LIQUIDITY AND EFFICIENCY IN THREE RELATED FOREIGN EXCHANGE OPTIONS MARKETS
We would like to thank Ken Garbade, Viral Acharya, Roi Stein and Rafi Eldor for helpful comments. We also like to thank David Afriat for technical assistance and the late Dror Shalit for providing the data from the Tel Aviv Stock Exchange. Thanks are also due to the participants of the annual meeting of the Israeli Economic Association (2006), the participants of the weekly faculty seminar at Massey University, Auckland and the participants of the NYU Down Under Derivatives conference at Melbourne University.
The foreign currency market in a small open economy, like Israel, plays a major role in fiscal and monetary policy decisions, through its effects on the financial markets and the real economy. This has become even more evident in the recent financial crisis. In this paper we explore the relationship among three related foreign exchange options markets. The unique data set on OTC trading, on central bank options' auctions, in addition to the exchange traded ones provide us with insights about: (a) the effect of different financial infra-structures on prices, on limits to arbitrage, on their information content (forecasting volatility) and on the interrelationship between illiquidity and volatility, (b) the micro- structure interrelatedness between the FX spot market and the FX options market.
