Option Prices and the Probability of Success of Cash Mergers

55 Pages Posted: 20 Mar 2009 Last revised: 18 Nov 2020

See all articles by Alan Bester

Alan Bester

University of Chicago Graduate School of Business

Victor Hugo Martinez

Baruch College, City University of New York, Department of Economics and Finance

Ioanid Rosu

HEC Paris - Finance Department

Date Written: November 17, 2020

Abstract

We study both theoretically and empirically option prices on firms undergoing a cash merger offer. To estimate the merger's success probability, we use a Markov Chain Monte Carlo (MCMC) method using a state space representation of our model. Our estimated probability measure has significant predictive power for the merger outcome even after controlling for variables used in the merger literature. As predicted by the model, a graph of the target firm's implied volatility against the strike price has a kink at the offer price, and the kink's magnitude is proportional to the merger's success probability.

Keywords: Mergers and acquisitions, Black and Scholes formula, success probability, fallback price, Markov Chain Monte Carlo, implied volatility curve, volatility smile

JEL Classification: G13, G34, C58

Suggested Citation

Bester, Alan and Martinez, Victor Hugo and Rosu, Ioanid, Option Prices and the Probability of Success of Cash Mergers (November 17, 2020). AFA 2010 Atlanta Meetings Paper, HEC Paris Research Paper No. FIN-2017-1213, Available at SSRN: https://ssrn.com/abstract=1364491 or http://dx.doi.org/10.2139/ssrn.1364491

Alan Bester

University of Chicago Graduate School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-834-1714 (Phone)

Victor Hugo Martinez

Baruch College, City University of New York, Department of Economics and Finance ( email )

55 Lexington Avenue
New York, NY 10010
United States
(646) 312 3411 (Phone)

HOME PAGE: http://faculty.baruch.cuny.edu/vmartinez

Ioanid Rosu (Contact Author)

HEC Paris - Finance Department ( email )

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France

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