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. Show more