Take the 2-minute tour ×
Quantitative Finance Stack Exchange is a question and answer site for finance professionals and academics. It's 100% free, no registration required.

What are practically useful ways of modelling the effect of liquidity on options?

share|improve this question
add comment

1 Answer 1

In general liquidity is most often modeled, for most types of instruments, via proxy by the 'bid-ask spread' (wider = less liquid, narrower = more liquid)

You can choose to model the bid-ask spread in dollars, or what is often most helpful, for options, is to model the bid-ask spread in terms of implied volatility (of the difference between the bid and ask prices). This lets you make consistent cross-sectional comparisons of liquidity, and do hypothesis testing.

here's a sample paper that uses the implied vol appraoch: http://www.ccfr.org.cn/cicf2010/papers/20091215131015.pdf

share|improve this answer
add comment

Your Answer

 
discard

By posting your answer, you agree to the privacy policy and terms of service.

Not the answer you're looking for? Browse other questions tagged or ask your own question.