Abstract

This paper attempts to discover the macroeconomic determinants of liquidity in option markets, which is measured by the open interest, the volume (number of transactions), the implied volatility and the bid-ask spread. The macroeconomic determinants of each European economy employed in this study are 1) the gross domestic product, the gross domestic product per capita, the unemployment rate, the income tax rate, the corporate tax rate, the population, the bank capital-to-assets ratio, the inflation, the 10-year government bond yield rate, 2) the market capitalization (of listed domestic companies), the Standard & Poor’s global equity indices (annual % change), the stocks traded (turnover ratio of domestic shares (%) and total value), which show the breadth of a country’s capital markets, as well as 3) indices like the economic freedom, the freedom from corruption, the fiscal freedom, the business freedom, the investment freedom, the financial freedom. Panel data linear regressions are performed to find evidence that the liquidity of the option markets is mainly affected by macroeconomic and capital market determinants, whereas the economic freedom indicators play a less significant role. The findings can be of use to the policymakers and option market authorities who wish to increase the liquidity of these markets. The novelties introduced by this study are the consideration of macroeconomic variables as determinants of option market liquidity and the subsequent use of these determinants in order to make policy recommendations.

Highlights

  • IntroductionPappas exchanges and market participants who faced decreased liquidity in certain exchanges, especially during or after the financial crisis

  • This paper attempts to discover the macroeconomic determinants of liquidity in option markets, which is measured by the open interest, the volume, the implied volatility and the bid-ask spread

  • The volume is positively correlated with the inflation, the 10-year government bond yield, the business freedom, the market capitalization, the financial freedom, the income tax rate and the stocks traded value at the 1% level. It is negatively correlated with the economic freedom, the investment freedom and the population and the previous year volume at the 1% level when the dynamic panel data model is used

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Summary

Introduction

Pappas exchanges and market participants who faced decreased liquidity in certain exchanges, especially during or after the financial crisis. This was more apparent in distressed countries, especially the ones that had to rely on support mechanisms in the European South, with the most prominent example being Greece. The interested parties realized that the authorities most likely had to take action in order to increase liquidity and they needed some answers in terms of whether it was solely an issue of the derivatives exchange authorities or the policymakers of the country as a whole. Investigating the impact of macroeconomic metrics, (equity) market characteristics, as well as perceived economic freedom to the liquidity of the derivatives market offers potential answers and paves the path for potential measures that if implemented, could assist in overcoming the exhibited illiquidity. As option markets have been in the spotlight this study investigates the determinants of their liquidity

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