The Price of Options Illiquidity


  • Menachem Brenner,

  • Rafi Eldor,

  • Shmuel Hauser

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    • Brenner is from the Stern School of Business, New York University. Eldor is from the Arison Business School, IDC, Herzelia. Hauser is from the School of Management, Ben Gurion University, and from the Israel Securities Authority. We would like to thank Yakov Amihud, Orit Halvitz, Bill Silber, Meir Sokoler, Raghu Sundaram, Tony Saunders, Marti Subrahmanyam, and Sanjay Unni for their helpful comments and suggestions. Special thanks to Ken Garbade for spending many hours reading and commenting on every draft of this paper. Many thanks to the Bank of Israel and the Tel-Aviv Stock Exchange for providing the data and responding to our innumerable questions. Finally, we thank René Stulz and the referee of this paper for their many helpful comments and suggestions.


The purpose of this paper is to examine the effect of illiquidity on the value of currency options. We use a unique dataset that allows us to explore this issue in special circumstances where options are issued by a central bank and are not traded prior to maturity. The value of these options is compared to similar options traded on the exchange. We find that the nontradable options are priced about 21 percent less than the exchange-traded options. This gap cannot be arbitraged away due to transactions costs and the risk that the exchange rate will change during the bidding process.