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

Abstract

Using a fast numerical technique, we investigate a large database of investors' suboptimal nonexercise of short-maturity American call options on dividend-paying stocks listed on the Dow Jones. The correct modeling 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 the amount lost by investors through suboptimal exercise by one-quarter. 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.