From funding liquidity to market liquidity: Evidence from the index options market

Abstract

This study examines the relationship between funding liquidity and market liquidity using daily data on the S&P 500 index options. We find that options market liquidity is positively correlated with funding liquidity after controlling for market uncertainty. Further analysis reveals that the positive relationship between funding liquidity and market liquidity in the options market is mainly driven by short‐term and deep out‐of‐the‐money options. Our results remain robust after controlling for the confounding effects of the equity market and different data frequencies.

Sentiment‐dependent impact of funding liquidity shocks on futures market liquidity

“…Second, sentiment shocks negatively impact futures market liquidity, indicating that investors prefer futures contracts when economic sentiment is pessimistic. We confirm that the sentiment effect is significant even after controlling for the impact of implied volatility, which is discovered by Liu et al (2018). Third, optimistic (pessimistic) sentiment reinforces (weakens) the negative relationship between funding liquidity and futures market liquidity.…”

“…They also provide evidence that the two markets respond interactively to funding liquidity shocks. Liu et al (2018) also find that the effect of funding liquidity, proxied by the Treasury-Eurodollar (TED) spread, significantly and positively forms market liquidity. Deuskar and Johnson (2021) emphasize the role of local funding services over interest rate changes, in contributing to funding availability for investors and shaping liquidity in the government bond market.…”

“…Thus, because the trading 1 Unlike futures markets, options markets' reactions to funding liquidity shocks are somewhat explored. Liu et al (2018) and Jylhä (2018) both investigate the effect of funding liquidity on index options market liquidity in the US market. They find that funding liquidity positively impacts options market liquidity.…”

“…The majority of the studies investigating the relationship between funding liquidity and market liquidity focus on liquidity spirals in the stock or bond markets, while those in the futures market did not receive much attention. Though Liu et al (2018) investigate the options market, which is also an important derivative market, we provide substantial contributions beyond that offered by their findings. First, our study is the first to investigate the effect of funding liquidity on market liquidity in the context of a futures market.…”

Market Illiquidity Premium on Stock Returns: An Empirical Study of Taiwan Stock Markets

“…Guo et al (2017) provided strong support for the literature's conjecture that market wide liquidity is an important asset pricing risk factor. Liu et al (2018) also found that the options market liquidity was positively correlated with funding liquidity after controlling for market uncertainty. The positive relationship between funding liquidity and market liquidity in the options market was mainly driven by short-term and deep out-of-the-money options.…”