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Early exercise decision in American options with dividends, stochastic volatility and jumps

Profile image of Olivier ScailletOlivier Scaillet

2016, arXiv (Cornell University)

https://doi.org/10.48550/ARXIV.1612.03031
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Abstract

Using a fast numerical technique, we investigate a large database of investor suboptimal nonexercise of short maturity American call options on dividend-paying stocks listed on the Dow Jones. The correct modelling of the discrete dividend is essential for a correct calculation of the early exercise boundary as confirmed by theoretical insights. Pricing with stochastic volatility and jumps instead of the Black-Scholes-Merton benchmark cuts by a quarter the amount lost by investors through suboptimal exercise. The remaining three quarters are largely unexplained by transaction fees and may be interpreted as an opportunity cost for the investors to monitor optimal exercise.

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Using a fast numerical technique, we investigate a large database of investor suboptimal nonexercise of short maturity American call options on dividend-paying stocks listed on the Dow Jones. The correct modelling of the discrete dividend is essential for a correct calculation of the early exercise boundary as confirmed by theoretical insights. Pricing with stochastic volatility and jumps instead of the Black-Scholes-Merton benchmark cuts by a quarter the amount lost by investors through suboptimal exercise. The remaining three quarters are largely unexplained by transaction fees and may be interpreted as an opportunity cost for the investors to monitor optimal exercise. We would like to thank the editor and the referee for constructive criticism and numerous suggestions which led to substantial improvements over the previous version. We also thank J.

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  • Economics
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  • Financial Economics
  • Social Science Research Network
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