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Excess cash and equity option liquidity

Lookup NU author(s): Dr Minh Nguyen

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Abstract

This study examines the relationships between excess corporate cash holding and equity option market liquidity over the period from Jan 3, 2005 to Aug 31, 2015. We show that the level of cash reserve in excess of what can be captured by firm characteristics significantly explains the liquidity of stock options. Trading volume and open interests of the options increase in companies with a higher magnitude of excess cash while the bid-ask spreads of stock options decline in excess cash. Our findings confirm the theoretical predictions by Gopalan et al. (2012) that excess cash improves market liquidity as it reduces adverse selection problems caused by the uncertainty in firm valuations. The relation between excess cash and option market liquidity becomes more pronounced for firms with a greater degree of informed trading or during periods of high volatility in financial markets. Our result shows that when the uncertainty about prospects of firms rises, excess cash becomes more valuable and affects option market liquidity.

Publication metadata

Author(s): Deng M, Nguyen M

Publication type: Article

Publication status: Published

Journal: Journal of Financial Research

Year: 2024

Volume: 47

Issue: 2

Pages: 401-433

Print publication date: 01/06/2024

Online publication date: 20/12/2023

Acceptance date: 23/08/2023

Date deposited: 05/02/2024

ISSN (print): 0929-1199

ISSN (electronic): 1872-6313

Publisher: Elsevier BV

URL: https://doi.org/10.1111/jfir.12379

DOI: 10.1111/jfir.12379

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