Option Prices and the Probability of Success of Cash Mergers*

C Alan Bester, Victor H Martinez and Ioanid Roşu

Journal of Financial Econometrics, 2023, vol. 21, issue 1, 145-186

Abstract: We study both theoretically and empirically option prices on firms undergoing a cash merger offer. To estimate the merger’s success probability, we use a Markov Chain Monte Carlo (MCMC) method using a state space representation of our model. Our estimated probability measure has significant predictive power for the merger outcome even after controlling for variables used in the merger literature. As predicted by the model, a graph of the target firm’s implied volatility against the strike price has a kink at the offer price, and the kink’s magnitude is proportional to the merger’s success probability.

Keywords: : Black and Scholes formula; fallback price; implied volatility curve; Markov Chain Monte Carlo; mergers and acquisitions; success probability; volatility smile (search for similar items in EconPapers)
JEL-codes: C58 G13 G34 (search for similar items in EconPapers)
Date: 2023
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