Option implied volatilities and the cost of issuing equity |
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Affiliation: | 1. Deutsche Bundesbank, Wilhelm-Epstein-Straße 14, 60431 Frankfurt am Main, Germany;2. European University Institute, Economics Department, Villa San Paolo, Via della Piazzuola 43, 50133 Florence, Italy |
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Abstract: | The structure of a firm-commitment Seasoned Equity Offering (SEO) resembles a put-option underwritten by an investment bank syndicate (Smith, 1977). Employing implied volatilities from issuers’ stock options as a direct forward-looking measure, this paper examines the impact of expected price risk around SEO issue dates on the direct cost of issuing equity. Using a comprehensive sample of 1208 SEOs between 1996 and 2009, we find issuers with higher option implied volatilities raise less external equity capital and pay higher investment bank fees in the stock market, ceteris paribus. The effect of implied volatility on the investment bank fees is stronger for larger issuers with lower pre-SEO abnormal realized stock volatilities, and for SEOs with higher expected price pressures around issue dates. These relationships are robust to adjustments for correlations among control variables, sample selection bias and also simultaneous determination of offer size and SEO fees. |
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Keywords: | Seasoned Equity Offering Implied volatility Cost of equity Price risk Investment bank fees |
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