On the Use of Implied Volatilities in the Prediction of Successful Corporate Takeovers

Abstract

This paper develops and tests the notion that postannouncement prices from stock and option markets can be used to infer both the probability of success and timing of an attempted takeover. Using a sample of 65 cash tender offers from January 1980 to July 1989, we demonstrate that the pattern of implied stock volatilities generated from target firm options expiring around the takeover resolution date is strongly consistent with the hypothesis that prices anticipate the eventual outcome. We conclude that traders in the market for takeover candidates behave in a rational manner, although with less-than-perfect foresight.

JEL Classification: G34