American Put Index Options Early Exercise Premium Estimation

This paper examines empirically the value of early exercise by testing the ability of two American put valuation models to predict the early exercise premium for the S&P100 American put options. An accuracy test and a quality test are performed on (1) the MacMillan (1986) & Barone-Adesi and Whaley (1987) model, and (2) the Carr, Jarrow and Myneni (1992) model. The test results show that early exercise premium is significant regardless of moneyness. Moreover, consistent with the theory, the value of early exercise is significantly negatively related to moneyness and interest rates and significantly positively related to time to maturity and to the volatility of the underlying index. Both American put valuation models examined misprice the early exercise premium embedded in American put prices