ESO valuation with job termination risk and jumps in stock price

DOI10.1137/130937949MaRDI QIDQ2941470zbMATH OpenOpenAlexFDO

Authors Tim Leung, Haohua Wan

Publication date 28 August 2015

Published in SIAM Journal on Financial Mathematics (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1504.08073

zbMATH Keywords

Fourier transformemployee stock optionsvariational inequalityjob terminationLévy processes

Mathematics Subject Classification ID

Processes with independent increments; Lévy processes (60G51) Derivative securities (option pricing, hedging, etc.) (91G20) Variational inequalities (49J40) Stopping times; optimal stopping problems; gambling theory (60G40) Optimal stopping in statistics (62L15) Financial applications of other theories (91G80)

Abstract: Employee stock options (ESOs) are American-style call options that can be terminated early due to employment shock. This paper studies an ESO valuation framework that accounts for job termination risk and jumps in the company stock price. Under general L'evy stock price dynamics, we show that a higher job termination risk induces the ESO holder to voluntarily accelerate exercise, which in turn reduces the cost to the company. The holder's optimal exercise boundary and ESO cost are determined by solving an inhomogeneous partial integro-differential variational inequality (PIDVI). We apply Fourier transform to simplify the variational inequality and develop accurate numerical methods. Furthermore, when the stock price follows a geometric Brownian motion, we provide closed-form formulas for both the vested and unvested perpetual ESOs. Our model is also applied to evaluate the probabilities of understating ESO expenses and contract termination.

Recommendations

• ACCOUNTING FOR RISK AVERSION, VESTING, JOB TERMINATION RISK AND MULTIPLE EXERCISES IN VALUATION OF EMPLOYEE STOCK OPTIONS
• A top-down approach for the multiple exercises and valuation of employee stock options
• Pricing executive stock options under employment shocks
• A reduced form model for ESO valuation. Modelling the effects of employee departure and takeovers on the value of employee share options
• Valuation of employee stock options using the exercise multiple approach and life tables

Cites work

• scientific article; zbMATH DE number 1402217 (Why is no real title available?)
• A Fast and Accurate FFT-Based Method for Pricing Early-Exercise Options under Lévy Processes
• A Finite Difference Scheme for Option Pricing in Jump Diffusion and Exponential Lévy Models
• A jump-diffusion model for option pricing
• A penalty method for American options with jump diffusion processes
• A reduced form model for ESO valuation. Modelling the effects of employee departure and takeovers on the value of employee share options
• ACCOUNTING FOR RISK AVERSION, VESTING, JOB TERMINATION RISK AND MULTIPLE EXERCISES IN VALUATION OF EMPLOYEE STOCK OPTIONS
• Analysis of the optimal exercise boundary of American options for jump diffusions
• Fourier space time-stepping for option pricing with Lévy models
• Optimal stopping, free boundary, and American option in a jump-diffusion model
• Option pricing when underlying stock returns are discontinuous
• Perpetual options and Canadization through fluctuation theory
• Randomization and the American put
• Risk aversion and block exercise of executive stock options
• The Valuation of Executive Stock Options in an Intensity-Based Framework *
• The Variance Gamma Process and Option Pricing
• The critical price for the American put in an exponential Lévy model
• The pricing of options and corporate liabilities

Cited in

(8)

• Constrained viscosity solution to the HJB equation arising in perpetual American employee stock options pricing
• A top-down approach for the multiple exercises and valuation of employee stock options
• A humanized model of employee stock options in Black-Scholes framework
• Valuation of employee stock options using the exercise multiple approach and life tables
• Employee stock options. Exercise timing, hedging, and valuation
• A reduced form model for ESO valuation. Modelling the effects of employee departure and takeovers on the value of employee share options
• Employee stock options: an up-and-out protected barrier call
• The value of being lucky: option backdating and nondiversifiable risk

This page was built for publication: ESO valuation with job termination risk and jumps in stock price

Report a bug (only for logged in users!)Click here to report a bug for this page (MaRDI item Q2941470)