Cash Mergers and the Volatility Smile

58 Pages Posted: 20 Mar 2009 Last revised: 13 Apr 2019

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: April 13, 2019

Abstract

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

Bester, Alan and Martinez, Victor Hugo and Rosu, Ioanid, Cash Mergers and the Volatility Smile (April 13, 2019). 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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