Early Option Exercise: Never Say Never

Mads Vestergaard Jensen, Lasse Heje Pedersen

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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
TidsskriftJournal of Financial Economics
Vol/bind121
Udgave nummer2
Sider (fra-til)278-299
Antal sider22
ISSN0304-405X
DOI
StatusUdgivet - aug. 2016

Emneord

  • Option exercise
  • Frictions
  • Short-sale costs
  • Transaction costs
  • Convertible bonds

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