by
Allen M. Poteshman
Department of Finance
University of Illinois at Urbana-Champaign
and
Vitaly Serbin
Department of Finance
University of Illinois at Urbana-Champaign
Abstract
This paper analyzes the early exercise of Chicago Board Options Exchange
listed calls by different classes of investors over the 1996-1999 period.
We present two main findings. First, there are a large number of early
exercises that can be identified as clearly irrational without invoking
any model of market equilibrium, and these exercises are not uniformly
distributed across the investor classes. Customers of discount brokers
and customers of full service brokers both engage in a significant number
of irrational exercises while traders at large investment houses exhibit
no irrational early exercise behavior. Second, irrational exercise is triggered
both by the underlying stock price attaining its highest level over the
past year and by the underlying stock having high past returns. Our findings
provide evidence that prospect theory is operative in the options market
and that it applies differentially across various classes of investors.