The Early Exercise Risk Premium

55 Pages Posted: 16 Oct 2019 Last revised: 23 Dec 2019

See all articles by Kevin Aretz

Kevin Aretz

Alliance Manchester Business School

Adnan Gazi

University of Liverpool Management School

Date Written: December 21, 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 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

Aretz, Kevin and Gazi, Adnan, The Early Exercise Risk Premium (December 21, 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 )

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

Adnan Gazi (Contact Author)

University of Liverpool Management School ( email )

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