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An Empirical Test of the Pricing of VPO Contracts

Author

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  • John C. Handley

    (Department of Finance, University of Melbourne, VIC 3010.)

Abstract

A variable purchase option (VPO) is a call option issued by a company on a stochastic rather than on a fixed number of its ordinary shares. This paper tests the arbitrage-free pricing model of Handley (2000) using a transactions dataset of actual market prices covering the five VPOs traded on the Australian Stock Exchange during the six-year period from May 1992 to May 1998. It is initially found that the model systematically overprices VPOs. A subsequent case-based explanatory analysis of the pricing errors, however, shows that this mispricing substantially disappears under different estimates of two key parameters. The results are consistent with investors using risk-adjusted discount rates rather than the risk-free rate in valuing the bond component of the VPO and, when material, using a narrow range of volatility estimates, rather than historic volatility estimates, in valuing the option component of the VPO.

Suggested Citation

  • John C. Handley, 2003. "An Empirical Test of the Pricing of VPO Contracts," Australian Journal of Management, Australian School of Business, vol. 28(1), pages 1-21, June.
    • Handle: RePEc:sae:ausman:v:28:y:2003:i:1:p:1-21
    DOI: 10.1177/031289620302800101
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    References listed on IDEAS

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    1. Robert F. Engle & Jeffrey R. Russell, 1998. "Autoregressive Conditional Duration: A New Model for Irregularly Spaced Transaction Data," Econometrica, Econometric Society, vol. 66(5), pages 1127-1162, September.
    2. Rubinstein, Mark, 1985. "Nonparametric Tests of Alternative Option Pricing Models Using All Reported Trades and Quotes on the 30 Most Active CBOE Option Classes from August 23, 1976 through August 31, 1978," Journal of Finance, American Finance Association, vol. 40(2), pages 455-480, June.
    3. MacBeth, James D & Merville, Larry J, 1979. "An Empirical Examination of the Black-Scholes Call Option Pricing Model," Journal of Finance, American Finance Association, vol. 34(5), pages 1173-1186, December.
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    Cited by:

    1. Jan Vecer, 2013. "Asian options on the harmonic average," Quantitative Finance, Taylor & Francis Journals, vol. 14(8), pages 1315-1322, September.
    2. Manuel Moreno & Javier F. Navas, 2008. "Australian Options," Australian Journal of Management, Australian School of Business, vol. 33(1), pages 69-93, June.

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