Financial Engineering Seminar
February 23, 2007(Fri)
Time: 1:55 pm
Place: Weil Hall 307
Financial regulations now require that stock options that firms give their employees be expensed in accounting statements. These employee stock options (ESOs) have a number of complicating characteristics that distinguish them from standard market-traded American call options, and their value is consequently much less due to the suboptimal exercising strategies of the holders, which arise from risk aversion, trading and hedging constraints, and job termination risk. We analyze the combined effect of all of these factors along with multiple exercising rights, and vesting periods. This leads to the study of a chain of nonlinear free-boundary problems of reaction-diffusion type. We find that job termination risk, vesting, finite maturity and non-zero interest rates are significant contributors to the ESO cost, but that in the presence of vesting, the impact of allowing for multiple exercise rights on ESO cost is negligible.
Joint work with Tim Leung.