Smooth Pasting as Rate of Return Equalization

Sodal, Sigbjorn; Shackleton, Mark B.

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Smooth Pasting as Rate of Return Equalization

Economics Letters, Vol. 89, No. 2, pp. 200-206, November 2005

8 Pages Posted: 21 Apr 2005

See all articles by Sigbjorn Sodal

Mark B. Shackleton

Lancaster University - Department of Accounting and Finance

Abstract

We further elucidate the smooth pasting condition behind optimal early exercise of options. It is easy to show that smooth pasting implies rate of return equalization between the option and the levered position that results from exercise. This yields new economic insights into the optimal early exercise condition that the option holder faces.

Keywords: Smooth pasting, rates of return, option elasticity, real option

JEL Classification: G31, D92, D81, C61

Suggested Citation: Suggested Citation

Sodal, Sigbjorn and Shackleton, Mark B., Smooth Pasting as Rate of Return Equalization. Economics Letters, Vol. 89, No. 2, pp. 200-206, November 2005, Available at SSRN: https://ssrn.com/abstract=705121