The Value of an Option to Exchange One Asset for Another

William Margrabe

Rodney L. White Center for Financial Research Working Papers from Wharton School Rodney L. White Center for Financial Research

Abstract: In this paper I develop a model for the pricing of a European-type option to exchange one asset for another. I prove that a similar American-type option is never exercised until the last possible moment. Thus, the formula for the value of the American-type option is the same as that for the European-type option. This sort of option is not only a call option on the one asset, but also a put option on the other. Thus, the formula gives a closed-form expression for a special sort of American put option, and one can derive a put-call parity theorem for options of this sort. I also show how the model applies to four real-world financial arrangements; the investment advisor’s performance incentive fee, the general margin account, the corporate exchange offer, and the standby commitment.

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Persistent link: https://EconPapers.repec.org/RePEc:fth:pennfi:13-76

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