Kaeck, A., van Kervel, V. and Seeger, NormanJ. (2022). Price impact versus bid–ask spreads in the index option market Journal of Financial Markets, 59(Part A):1--22.
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Affiliated author
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Publication year2022
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JournalJournal of Financial Markets
We investigate the puzzle of why bid–ask spreads of options are so large by focussing on the price impact component of the spread. We propose a structural vector autoregressive model for trades in the option market to analyze whether they move the underlying price and/or the underlying's volatility. Our model captures cross-option strategies by pooling order flows across contracts after a decomposition into exposure to the underlying asset and its volatility. While our estimates confirm that S\&P500 option trades indeed significantly move the underlying and the volatility, the economic magnitudes are very small. Hence, large bid–ask spreads of options remain a puzzle.