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Article
Publication date: 1 October 1995

Roger P. Bey and Larry J. Johnson

The executive stock option (ESO) valuation model developed in this research amends the popular exchange traded option pricing models such as Black and Scholes (1973)…

Abstract

The executive stock option (ESO) valuation model developed in this research amends the popular exchange traded option pricing models such as Black and Scholes (1973), Whaley (1981), and Cox, Ross, and Rubinstein (1979) to include economic features of the ESO contract that previously have been ignored. One of these features is the non‐transferability of the ESO, which creates a situation where the ESO might be exercised when an otherwise identical exchange traded option would not. Another feature is the hybrid nature of the ESO; it is not solely either an American option or a European option. The results of the comparative statics indicate that the impact of the non‐transferability of the ESO value is significant, whereas the hybrid feature of the ESO results in values that are very similar to American option values. The economic implication is that if an American or European option model is used to value ESO's, the probability is very high that a wealth transfer between management and shareholders will occur.

Details

Managerial Finance, vol. 21 no. 10
Type: Research Article
ISSN: 0307-4358

Article
Publication date: 3 July 2007

Steve Easton and Irena Ivanovic

The paper seeks to examine fair values provided by the Australian Stock Exchange (ASX) and reported daily in the Australian Financial Review to determine whether they…

773

Abstract

Purpose

The paper seeks to examine fair values provided by the Australian Stock Exchange (ASX) and reported daily in the Australian Financial Review to determine whether they violate fundamental option relationships.

Design/methodology/approach

Values reported in the Australian Financial Review from 4 January 2005 to 31 March 2005 are examined.

Findings

The results document that between 1 and 2 per cent violate the most fundamental option relationships, specifically the requirement for call and put option values to increase as term to expiry increases, and for call (put) option values to increase (decrease) as exercise price decreases. Further, the magnitude of these violations is too large to be explained solely by the bid‐ask spread. They are, nevertheless, consistent with staleness. Further, in nearly 30 per cent of cases these fair values violate the basic put‐call parity relationship. The type of these violations is also consistent with these values being stale.

Research limitations/implications

Simple screens should be included to remove fair values that breach the most basic relationships.

Originality/value

The paper is the first to highlight flaws in fair values provided by the Australian Stock Exchange (ASX) and reported in the Australian Financial Review.

Details

International Journal of Managerial Finance, vol. 3 no. 3
Type: Research Article
ISSN: 1743-9132

Keywords

Article
Publication date: 20 April 2010

Peter Klein and Jun Yang

The purpose of this paper is to extend the models of Johnson and Stulz, Klein and Klein and lnglis to analyse the properties of vulnerable American options.

Abstract

Purpose

The purpose of this paper is to extend the models of Johnson and Stulz, Klein and Klein and lnglis to analyse the properties of vulnerable American options.

Design/methodology/approach

The presented model allows default prior to the maturity of the option based on a barrier which is linked to the payoff on the option. Various measures of risk denoted by the standard Greek letters are studied, as well as additional measures that arise because of the vulnerability.

Findings

The paper finds that the delta of a vulnerable American put does not always increase with the price of the underlying asset, and may be significantly smaller than that of a non‐vulnerable put. Because of deadweight costs associated with bankruptcy, delta and gamma are undefined for some values of the underlying asset. Rho may be considerably higher while vega may be smaller than for non‐vulnerable options. Also, the probability of early exercise for vulnerable American options is higher and the price of the underlying asset at which this is optimal depends on the degree of credit risk of the option writer.

Originality/value

This paper makes a contribution to understanding the effect of credit risk on option valuation.

Details

Managerial Finance, vol. 36 no. 5
Type: Research Article
ISSN: 0307-4358

Keywords

Abstract

Details

Energy Power Risk
Type: Book
ISBN: 978-1-78743-527-8

Abstract

Details

New Principles of Equity Investment
Type: Book
ISBN: 978-1-78973-063-0

Book part
Publication date: 5 July 2012

Kavous Ardalan

The purpose of this chapter is to discuss the potential contribution of the option applications to economic instability. To this end, the chapter briefly reviews the…

Abstract

The purpose of this chapter is to discuss the potential contribution of the option applications to economic instability. To this end, the chapter briefly reviews the extant literature on financial option pricing and its applications to corporate assets and liabilities. It focuses on the direct relationship between the volatility of the underlying asset and the value of the option. It shows that the theory of option applications by its one-sided emphasis on the value-creating role of volatility promotes excessive risk-taking. Then the chapter discusses how the theory of option applications through the educational system encourages economic agents to make excessively risky decisions. Furthermore, the interactions among these risk-welcoming agents lead to an economic system which becomes increasingly risky. This risky economy, combined with the fact that more than half of the value of the option applications is constituted by the highly volatile value of the options embedded in such applications, translates into wide variations in real investments and the economy.

Details

Derivative Securities Pricing and Modelling
Type: Book
ISBN: 978-1-78052-616-4

Keywords

Book part
Publication date: 13 August 2007

Todd Fister and Anju Seth

This paper complements previous research on investment in firm-specific human capital by applying real options analysis. Our framework suggests that the parties receive…

Abstract

This paper complements previous research on investment in firm-specific human capital by applying real options analysis. Our framework suggests that the parties receive valuable options to exit the contract when information becomes revealed in the future, but these options may be more valuable for one party than the other. Companies and workers attempt to reduce the value of the options through contractual mechanisms that either shift wealth to the party granting the option or prevent the option from being exercised. In both cases, the mechanisms cause the parties to invest in firm-specific capital, resulting in higher output and higher wages.

Details

Real Options Theory
Type: Book
ISBN: 978-0-7623-1427-0

Book part
Publication date: 27 June 2014

Andrew H. Chen, James A. Conover and John W. Kensinger

Analysis of Information Options offers new tools for evaluating investments in research, mineral exploration, logistics, energy transmission, and other information…

Abstract

Analysis of Information Options offers new tools for evaluating investments in research, mineral exploration, logistics, energy transmission, and other information operations. With Information Options, the underlying assets are information assets and the rules governing exercise are based on the realities of the information realm (infosphere). Information Options can be modeled as options to “purchase” information assets by paying the cost of the information operations involved. Information Options arise at several stages of value creation. The initial stage involves observation of physical phenomena with accompanying data capture. The next refinement is to organize the data into structured databases. Then bits of information are selected from storage and synthesized into an information product (such as a management report). Next, the information product is presented to the user via an efficient interface that does not require the user to be a field expert. Information Options are similar in concept to real options but substantially different in their details, since real options have physical objects as the underlying assets and the rules governing exercise are based on the realities of the physical world. Also, while exercising a financial option typically kills the option, Information Options may include multiple exercises. Information Options may involve high volatility or jump processes as well, further enhancing their value. This chapter extends several important real option applications into the information realm, including jump process models and models for valuing options to synthesize any of n information items into any of m output assets.

Book part
Publication date: 15 August 2007

Don M. Chance and Tung-Hsiao Yang

In some contexts, this illiquidity of executive stock options is referred to as non-transferability. In others, the problem is cast in terms of the highly concentrated…

Abstract

In some contexts, this illiquidity of executive stock options is referred to as non-transferability. In others, the problem is cast in terms of the highly concentrated portfolios that managers hold, an implication of which is that managers could not trade the options to diversify. The notion of option liquidity usually conjures up images of trading pits at the Chicago Board Options Exchange or other exchanges. The existence of an active trading pit gives a powerful visual image of liquidity, but, as evidenced by the success of electronic options exchanges such as New York's International Securities Exchange and Frankfurt's EUREX, a trading pit is hardly a requirement for liquidity. The existence of a guaranteed market for standardized options as implied by options exchanges (whether pit-based or electronic) further gives a misleading appearance of high liquidity. There is also a very large market for customized over-the-counter options. It is a misconception to think that these options are not liquid when they are simply not standardized. If an investor can create a highly customized long position in an option, that investor should be able to create a highly customized short position in the same option at a later date before expiration. If both options are created through the same dealer, they will usually be treated as an offset, as they would if they were standardized options clearing through a clearinghouse. If the two transactions are not with the same dealer, they would both remain alive, but the market risks would offset. Only the credit risk, a factor we ignore in this paper, would remain. Hence, these seemingly illiquid options are, for all practical purposes, liquid.2

Details

Issues in Corporate Governance and Finance
Type: Book
ISBN: 978-1-84950-461-4

Article
Publication date: 12 July 2022

Kavous Ardalan

The purpose of this paper is to use some of the contributions of the option pricing theory to solve three outstanding puzzles in finance: the underdiversification puzzle…

Abstract

Purpose

The purpose of this paper is to use some of the contributions of the option pricing theory to solve three outstanding puzzles in finance: the underdiversification puzzle, the volatility puzzle and the equity premium puzzle.

Design/methodology/approach

To approach the issue, this paper considers the applications of the option pricing theory to both sides of the corporate balance sheet. Applications to the left-hand side of the balance sheet has led to the real options theory that has expressed the value of a capital budgeting project as the sum of the values of its “discounted cash flow (DCF) method” and “real options.” This paper argues that, because the balance sheet must balance, the value of equity, which appears on the right-hand side of the balance sheet, should also be expressed as the sum of the values of its “DCF method” and “equity options.”

Findings

This proposed model of equity valuation solves the three outstanding puzzles in finance: the underdiversification puzzle, the volatility puzzle and the equity premium puzzle.

Research limitations/implications

This study may not be able to explain the full extent of the three puzzles.

Practical implications

The dividend discount model of equity valuation needs to be augmented by an option component.

Social implications

The community of finance scholars will become more confident of their scholarly work because three puzzles will be solved to a great extent.

Originality/value

To the best of author’s knowledge, the extant literature does not either solve any single one of the three puzzles through the contributions of option pricing theory or solve all three puzzles at the same time with a single solution. The originality of this paper is that it makes both of these contributions to the extant literature.

Details

Studies in Economics and Finance, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 1086-7376

Keywords

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