Option Pricing on Stocks in Mergers and Acquisitions


  • Ajay Subramanian

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    • Ajay Subramanian is Assistant Professor, DuPree College of Management, Georgia Institute of Technology. I especially wish to thank the anonymous referee for several insightful comments and suggestions that have significantly improved the paper. Special thanks are also due to Anand Venkateswaran for his invaluable help throughout this project. I also thank Rick Green (the editor); Antonio Camara; Peter Carr; Jonathan Clarke; Cheol Eun; Ping Hu; Jayant Kale; Narayanan Jayaraman; Nagesh Murthy; Husayn Shahrur; Milind Shrikhande; and seminar participants at the All-Georgia Finance Conference (Atlanta, 2001), the 12th Annual Derivative Securities Conference (New York City, 2002), the Second World Congress of the Bachelier Finance Society (Crete, 2002), and the FMA Annual Meeting (San Antonio, 2002) for valuable comments on earlier versions of the paper. All errors remain my sole responsibility.


We develop an arbitrage-free and complete framework to price options on the stocks of firms involved in a merger or acquisition deal allowing for the possibility that the deal might be called off at an intermediate time, creating discontinuous impacts on the stock prices. Our model can be a normative tool for market makers to quote prices for options on stocks involved in such deals and also for traders to control risks associated with such deals using traded options. The results of tests indicate that the model performs significantly better than the Black–Scholes model in explaining observed option prices.