The Early Exercise Risk Premium
55 Pages Posted: 16 Oct 2019 Last revised: 23 Dec 2019
Date Written: December 21, 2019
We study the asset pricing implications of being able to optimally early exercise a plain-vanilla put option, contrasting the expected returns of equivalent American and European put options. Standard pricing models with stochastic volatility and asset-value jumps suggest the expected return spread between those option types is positive, can be economically sizable, 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 formed from applying put-call parity to American call options on zero-dividend stocks, our empirical work supports our predictions.
Keywords: Empirical asset pricing, cross-sectional option pricing, put options, early exercise
JEL Classification: G11, G12, G15
Suggested Citation: Suggested Citation