- LoginAccess your ApplicationOr learn more about our programmes and applyAccess MyINSEAD
Bart Zhou Yueshen
Assistant Professor of Finance
Derivatives; Options; Liquidity Risk Premium; Liquidity Measure; Price Impact; Price Reversal
Huang S., Yueshen B. Z., Cheng Z. (Forthcoming). Derivatives and Market (Il)Liquidity Journal of Financial and Quantitative Analysis
The authors study how derivatives (with nonlinear payoffs) affect the underlying asset’s liquidity. In a rational expectations equilibrium, informed investors expect low conditional volatility and sell derivatives to the others. These derivative trades affect different investors’ utility differently, possibly amplifying liquidity risk.As investors delta hedge their derivative positions, price impact in the underlying drops, suggesting improved liquidity, because informed trading is diluted.In contrast, effects on price reversal are ambiguous, depending on investors’ relative delta hedging sensitivity, i.e., the gamma of the derivatives.The model cautions of potential disconnections between illiquidity measures and liquidity risk premium due to derivatives trading.