Over-the-Counter Option Market Dividend Protection and “Biases” in the Black-Scholes Model: A Note

Authors

  • ROBERT GESKE,

  • RICHARD ROLL,

  • KULDEEP SHASTRI

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    • Geske and Roll are from the Graduate School of Management, University of California, Los Angeles, and Shastri is from the Graduate School of Business, University of Pittsburgh.

      We thank the CIVITAS Foundation at the University of California, Los Angeles, and the Graduate School of Business at the University of Pittsburgh for financial support. We also thank Michael Brennan and Jon Ingersoll for their comments.


ABSTRACT

Most options are traded over-the-counter (OTC) and are dividend “protected;” the exercise price decreases on the ex date by an amount equal to the dividend. This protection completely inhibits the early exercise of American call options. Nevertheless, OTC-protected options have market values which differ systematically from Black-Scholes values for European options on non-dividend paying stocks. The pricing difference is related to both the variance of the underlying stock return and to time until expiration of the option, but it is quite small in dollar amount.

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