Early Option Exercise: Never Say Never

Lasse Heje Pedersen, Mads Vestergaard Jensen

Publikation: Working paperForskning

Abstrakt

A classic result by Merton (1973) is that, except just before expiration or dividend payments, one should never exercise a call option and never convert a convertible bond. We show theoretically that this result is overturned when investors face frictions. Early option exercise can be optimal when it reduces short-sale costs, transaction costs, or funding costs. We provide consistent empirical evidence, documenting billions of dollars of early exercise for options and convertible bonds using unique data on actual exercise decisions and frictions. Our model can explain as much as 98% of early exercises by market makers and 67% by customers.
OriginalsprogEngelsk
Udgivelses stedLondon
UdgiverCentre for Economic Policy Research
Antal sider64
StatusUdgivet - dec. 2015
NavnCentre for Economic Policy Research. Discussion Papers
Nummer11019
ISSN0265-8003

Emneord

  • Convertible bonds
  • Derivatives pricing
  • Frictions
  • Option exercise
  • Short‐sale costs
  • Transaction costs

Citationsformater