The Early Exercise Risk Premium

53 Pages Posted: 16 Oct 2019 Last revised: 18 Nov 2019

See all articles by Kevin Aretz

Kevin Aretz

Alliance Manchester Business School

Adnan Gazi

University of Manchester

Date Written: November 16, 2019

Abstract

We study the asset pricing implications of being able to optimally early exercise a plain-vanilla put option, contrasting the expected returns of American and equivalent European put options. Standard asset pricing models - including models with stochastic volatility and jumps - suggest that the spread in the expected return between the American and European options is positive and widens with a higher early exercise probability, as induced through a higher moneyness, shorter time-to-maturity, or lower underlying-asset volatility. Studying single-stock American put options and equivalent synthetic European options, which we form from applying put-call parity to American call options written on zero-dividend stocks, our empirical work strongly supports our theoretical predictions.

Keywords: Empirical asset pricing, cross-sectional option pricing, put options, early exercise

JEL Classification: G11, G12, G15

Suggested Citation

Aretz, Kevin and Gazi, Adnan, The Early Exercise Risk Premium (November 16, 2019). Available at SSRN: https://ssrn.com/abstract=3465453 or http://dx.doi.org/10.2139/ssrn.3465453

Kevin Aretz

Alliance Manchester Business School ( email )

Crawford House
Oxford Road
Manchester M13 9PL, Lancashire
United Kingdom
+44(0) 161 275 6368 (Phone)
+44(0) 161 275 4023 (Fax)

HOME PAGE: http://www.kevin-aretz.com

Adnan Gazi (Contact Author)

University of Manchester ( email )

Oxford Road
Manchester, M13 9PL
United Kingdom

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