The bid-ask spread of bank-issued options: a quantile regression analysis

In this paper we study the bid-ask spread of covered warrants, which are securitized derivatives also referred to as bank-issued options. We find that most of the factors affecting the size of the bid-ask spread for covered warrants are common to those affecting the bid-ask spread of regular options (such as hedging costs and order processing costs). However, we also find two results that are specific to covered warrants. First, competition among warrant issuers does not play an important role in reducing covered warrant bid-ask spread. Second, warrant market makers set the bid-ask spread taking into account the risk of trading with scalpers. We estimate quantile regressions to check whether the relations between the covered warrant bid-ask spread and explanatory variables depend on the size of the spread and to check whether results are robust to outliers. We find that the coefficient associated with hedging costs increases considerably as the size of the bid-ask spread increases, implying that a change in the hedging costs affects more warrants with wide bid-ask spread than warrants with tight bid-ask spread.