A REEXAMINATION OF OPTION VALUES IMPLICIT IN CALLABLE TREASURY BONDS

Longstaff(l992) and Edleson, Fehr, and Mason (1993) examine option val ues implicit in callable Treasury bonds and report a significant puzzl e: implied option values are frequently negative. Using an alternative approach, we reexamine this issue and find that implied option values are generally positive, and, in contrast to previous studies, instanc es of option values sufficiently negative to overcome the bid-ask spre ad are rare. We explain the findings in other studies by showing that the method used may lead to the appearance of a negative option value when the true value is positive.