The role of implied volatility in liquidity provision

Daniel Cahill; Kingsley Fong; Marvin Wee; Joey Wenling Yang

doi:10.1177/0312896219833423

The role of implied volatility in liquidity provision

Daniel Cahill, Kingsley Fong, Marvin Wee, Joey Wenling Yang^*

^*Corresponding author for this work

Research output: Contribution to journal › Article › peer-review

Abstract

This article examines the informational volatility – the permanent component of volatility that is driven by information – and its effect on stock liquidity provision. Using option-implied volatility as a proxy for informational volatility, our results show it has a significant negative influence on liquidity provision prior to earnings announcement even after controlling for trade-related market conditions. We find the effect of informational volatility only exists on the bid-side but not the ask-side of the order book. Further analysis suggests that the information contained in implied volatility concerns the future uncertainty of the underlying stock. JEL Classification: G12, G14, G30.

Original language	English
Pages (from-to)	45-71
Number of pages	27
Journal	Australian Journal of Management
Volume	45
Issue number	1
DOIs	https://doi.org/10.1177/0312896219833423
Publication status	Published - 1 Feb 2020

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title = "The role of implied volatility in liquidity provision",

abstract = "This article examines the informational volatility – the permanent component of volatility that is driven by information – and its effect on stock liquidity provision. Using option-implied volatility as a proxy for informational volatility, our results show it has a significant negative influence on liquidity provision prior to earnings announcement even after controlling for trade-related market conditions. We find the effect of informational volatility only exists on the bid-side but not the ask-side of the order book. Further analysis suggests that the information contained in implied volatility concerns the future uncertainty of the underlying stock. JEL Classification: G12, G14, G30.",

keywords = "Earnings announcement, implied volatility, liquidity provision, market depth",

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AU - Wee, Marvin

AU - Yang, Joey Wenling

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Y1 - 2020/2/1

N2 - This article examines the informational volatility – the permanent component of volatility that is driven by information – and its effect on stock liquidity provision. Using option-implied volatility as a proxy for informational volatility, our results show it has a significant negative influence on liquidity provision prior to earnings announcement even after controlling for trade-related market conditions. We find the effect of informational volatility only exists on the bid-side but not the ask-side of the order book. Further analysis suggests that the information contained in implied volatility concerns the future uncertainty of the underlying stock. JEL Classification: G12, G14, G30.

AB - This article examines the informational volatility – the permanent component of volatility that is driven by information – and its effect on stock liquidity provision. Using option-implied volatility as a proxy for informational volatility, our results show it has a significant negative influence on liquidity provision prior to earnings announcement even after controlling for trade-related market conditions. We find the effect of informational volatility only exists on the bid-side but not the ask-side of the order book. Further analysis suggests that the information contained in implied volatility concerns the future uncertainty of the underlying stock. JEL Classification: G12, G14, G30.

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KW - liquidity provision

KW - market depth

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The role of implied volatility in liquidity provision

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