Abstract
We investigate the extent to which firms' cost of debt may be affected by the presence of an active options market for the stock. Our baseline results reveal a detrimental effect of options trading volume on bond yield spreads and bond credit ratings. Specifically, a one-standard-deviation increase in options trading volume from its mean is associated with a 10-basis-point increase in the bond at-issue yield spread. We discuss the potential underlying mechanisms that channel the effect and show how options appear to increase the risk of bondholders being expropriated by shareholders. In particular, options seem to stimulate strategic default decisions by shareholders. Finally, using several econometric specifications and instrumental variable analysis, we argue that the nature of the effect is causal.
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