Cash Mergers and the Volatility Smile

Ioanid Rosu (), Victor Hugo Martinez () and Alan Bester ()

No 1213, HEC Research Papers Series from HEC Paris

Abstract: In an empirical study of cash mergers since 1996, we find that the equity options on target firms display a pronounced smile pattern in their implied volatilities which gets more pronounced when the merger success probability gets higher. We propose an arbitrage-free model to analyze option prices for firms undergoing a cash merger attempt. Our formula matches well the observed merger volatility smile. Furthermore, as predicted by the model, we show empirically that the merger volatility smile has a kink at the offer price, and that the magnitude of the kink is proportional to the merger success probability.

Keywords: Mergers and acquisitions; Black-Scholes formula; success probability; fallback price; Markov Chain Monte Carlo (search for similar items in EconPapers)
JEL-codes: G13 G34 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2017-11-21, Revised 2018-07-12
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:ebg:heccah:1213

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