AN ESTIMATION OF EARLY EXERCISE PREMIUM FOR AMERICAN PUT OPTIONS

This study empirically examines the value of early exercise and tests an American put valuation model's ability to predict the value of early exercise for American put options. This study performs three tests of the 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 of put prices predicted by the model lie outside American put-call parity bounds even after filtering the sample based on no-arbitrage conditions.