K. Aretz and A. Gazi: The Early Exercise Risk Premium

November 16, 2019

We study the asset pricing implications of being able to optimally early exercise a plain-vanilla put option, contrasting the expected returns of American and equivalent European put options. Standard asset pricing models - including models with stochastic volatility and jumps - suggest that the spread in the expected return between the American and European options is positive and widens with a higher early exercise probability, as induced through a higher moneyness, shorter time-to-maturity, or lower underlying-asset volatility.