On the Use of Implied Stock Volatilities in the Prediction of Successful Corporate Takeovers

Giovanni Barone-Adesi, Keith C. Brown and W. V. Harlow

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

Abstract: This paper develops and tests the notion that it is possible to use the post-announcement prices from the stock and option markets to infer both the probability of success and timing of an attempted takeover. Using a sample of 65 cash tender offers from the period January 1980 to July 1989, we demonstrate that the sequence of implied stock volatilities generated from the options of the target firm expiring both before and after the resolution date of the proposed deal exhibit a pattern strongly consistent with the hypothesis that prices are set in anticipation of the eventual outcome. We conclude that traders in the market for takeover candidates behave in a rational manner, although with less-than-perfect foresight.

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