Early Option Exercise: Never Say Never

Lasse Pedersen and Mads Vestergaard Jensen

No 11019, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: 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.

Keywords: Convertible bonds; Derivatives pricing; frictions; Option exercise; Short-sale costs; Transaction costs (search for similar items in EconPapers)
JEL-codes: G11 G12 G13 G14 (search for similar items in EconPapers)
Date: 2015-12
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://cepr.org/publications/DP11019 (application/pdf)

Related works:
Journal Article: Early option exercise: Never say never (2016)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:11019

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP11019

Access Statistics for this paper

More papers in CEPR Discussion Papers from Centre for Economic Policy Research 33 Great Sutton Street, London EC1V 0DX, UK.
Bibliographic data for series maintained by CEPR ().