AN ESTIMATION OF EARLY EXERCISE PREMIUM FOR AMERICAN PUT OPTIONS
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This study empirically examines the value ofearly exercise and tests an American put valuation models ability to predict the value ofearly exercise for American put options. This study performs three tests ofthe MacMillan (1986) and Barone-Adesi and Whaley (1987) American put valuation model: an accuracy test, a quality test, and a validity test. The results suggest that: (1) Early exercise premia for out-of-the-money put options were significant. (2) Consistent with theoretical predictions, the value of early exercise is significantly positively related to stock return volatility, interest rates, time to maturity, and the degree to which an option is in-the-money. (3) The American put valuation model does not fully capture the value of early exercise embedded in American put prices. (4) A large proportion ofput prices predicted by the model lie outside American put-call parity bounds even after filtering the sample based on no-arbitrage conditions.
Abstract
This study empirically examines the value ofearly exercise and tests an American put valuation models ability to predict the value ofearly exercise for American put options. This study performs three tests ofthe MacMillan (1986) and Barone-Adesi and Whaley (1987) American put valuation model: an accuracy test, a quality test, and a validity test. The results suggest that: (1) Early exercise premia for out-of-the-money put options were significant. (2) Consistent with theoretical predictions, the value of early exercise is significantly positively related to stock return volatility, interest rates, time to maturity, and the degree to which an option is in-the-money. (3) The American put valuation model does not fully capture the value of early exercise embedded in American put prices. (4) A large proportion ofput prices predicted by the model lie outside American put-call parity bounds even after filtering the sample based on no-arbitrage conditions.