Discussion Paper Details

Please find the details for DP11019 in an easy to copy and paste format below:

Full Details   |   Bibliographic Reference

Full Details

Title: Early Option Exercise: Never Say Never

Author(s): Lasse Heje Pedersen and Mads Vestergaard Jensen

Publication Date: December 2015

Keyword(s): convertible bonds, derivatives pricing, frictions, option exercise, short-sale costs and transaction costs

Programme Area(s): Financial Economics

Abstract: A classic result by Merton (1973) is that, except just before expiration or dividend payments, one should never exercise a call option and never convert a convertible bond. We show theoretically that this result is overturned when investors face frictions. Early option exercise can be optimal when it reduces short-sale costs, transaction costs, or funding costs. We provide consistent empirical evidence, documenting billions of dollars of early exercise for options and convertible bonds using unique data on actual exercise decisions and frictions. Our model can explain as much as 98% of early exercises by market makers and 67% by customers.

For full details and related downloads, please visit:

Bibliographic Reference

Pedersen, L and Vestergaard Jensen, M. 2015. 'Early Option Exercise: Never Say Never'. London, Centre for Economic Policy Research.