Option trading and firm innovation

Abstract

We investigate whether active derivatives markets stimulates or inhibits firm innovation within R&D- intense industries. This is done by estimating the relationship between the volume on the option written on the firm’s stock and established measures of firm innovation. We find the relationship to be positive and robust for a number of innovation proxies. Specifically, firms with higher option volume generate more innovation per euro invested in R&D, assuming time-invariant heterogeneity in our sample. Our baseline model suggests an increase in innovation by 24% when option trading increase by 400%. This is in line with the hypothesis of the reduced information asymmetry associated with options trading activity leading to more efficient allocation of funds. We find that option volume impacts innovation almost exclusively through increasing R&D productivity, rather than also partly stimulating R&D spending. This is in contrast with earlier findings from in particular ​Blanco and Wehrheim (2017), who find both effects to be significant. We also briefly propose possible economical mechanisms for these findings, related to management's incentives and market competition.