An Empirical Test of the Pricing of VPO Contracts

John C. Handley
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John C. Handley: Department of Finance, University of Melbourne, VIC 3010.

Australian Journal of Management, 2003, vol. 28, issue 1, 1-21

Abstract: A variable purchase option (VPO) is a call option issued by a company on a stochastic rather than on a fixed number of its ordinary shares. This paper tests the arbitrage-free pricing model of Handley (2000) using a transactions dataset of actual market prices covering the five VPOs traded on the Australian Stock Exchange during the six-year period from May 1992 to May 1998. It is initially found that the model systematically overprices VPOs. A subsequent case-based explanatory analysis of the pricing errors, however, shows that this mispricing substantially disappears under different estimates of two key parameters. The results are consistent with investors using risk-adjusted discount rates rather than the risk-free rate in valuing the bond component of the VPO and, when material, using a narrow range of volatility estimates, rather than historic volatility estimates, in valuing the option component of the VPO.

Keywords: VPO; OPTION; EQUITY CAPITAL; DILUTION (search for similar items in EconPapers)
Date: 2003
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:sae:ausman:v:28:y:2003:i:1:p:1-21

DOI: 10.1177/031289620302800101

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