NB: EXTRA SEMINAR THIS WEEK
Executives compensated with stock options generally receive grants periodically and so on
any given date, may have a portfolio of options of differing strikes and maturities on their
company’s stock. Non-transferability and trading restrictions in the company stock result in the executive facing unhedgeable risk. We employ exponential utility indifference pricing to analyse the optimal exercise thresholds for each option, option values and cost of the options to shareholders. Portfolio interaction effects mean that each of these differ, depending on the composition of the remainder of the portfolio. In particular, the cost to shareholders of an option portfolio is lowered relative to its cost computed on a per-option basis. The model can explain a number of empirical observations - which options are attractive to exercise first, how exercise changes following a new grant, and early exercise.
Joint work with Jia Sun and Elizabeth Whalley (WBS).