The Role of Stock Implied Volatility in Information Discovery: Evidence from Mergers and Acquisitions

This article investigates the relation between the options market and price discovery process in the context of mergers and acquisitions (M&A). Using a sample of mergers and acquisitions from 2005 to 2022, we document that the predictive power of the changes in implied volatility (IV) is statistically and economically significant. The results are robust when we adopt an instrumental variable approach to address the potential endogeneity issue. In addition, the risk arbitrage portfolios incorporating the signal derived from the options on target stocks generate annualized risk-adjusted abnormal returns between 4.1% and 5.1%, depending on the threshold of filters for the implied volatility change and the choice of asset pricing models. We find that our results are not explained by common equity risk factors.