Cash Mergers and the Volatility Smile
58 Pages Posted: 20 Mar 2009 Last revised: 13 Apr 2019
Date Written: April 13, 2019
In an empirical study of cash mergers, we find that the equity options on target firms display a pronounced smile pattern in their implied volatilities which gets more pronounced when the merger success probability gets higher. We propose an arbitrage-free model to analyze option prices for firms undergoing a cash merger attempt. Our formula matches well the observed merger volatility smile. Furthermore, as predicted by the model, we show empirically that the merger volatility smile has a kink at the offer price, and that the magnitude of the kink is proportional to the merger success probability.
Keywords: Mergers and Acquisitions, Black--Scholes Formula, Success Probability, Fallback Price, Markov Chain Monte Carlo
JEL Classification: G13, G34, C58
Suggested Citation: Suggested Citation