Analysing the bias in the primal-dual upper bound method for early exercisable derivatives: bounds,estimation and removal

We analyse the primal-dual upper bound method for Bermudan options and prove that its bias is inversely proportional to the number of paths in sub-simulations for a large class of cases. We develop a methodology for estimating and reducing the bias. We present numerical results showing that the new technique is indeed effective.     

A Model of Equity Based Compensation with Tax

In this paper, we develop a two‐stage continuous time model of employee stock option (ESO) valuation under different tax regimes. We show that tax rules can have significant effects on ESO exercise behavior. In addition, we find that incentive stock options (ISO) are the optimal form of compensation for all levels of employees in the UK. In the US, restricted stock plans are preferred, and tax breaks offered by incentive schemes are only beneficial to employees with high liquid wealth (or small option holdings relative to wealth) or low risk aversion. We also analyze 83b elections for restricted stock plans in the US and find that making an election is a sub‐optimal decision for both the employee and the firm.     

The informational content of the embedded deflation option in TIPS

We estimate the value of the embedded option in U.S. Treasury Inflation-Protected Securities (TIPS). The embedded option value exhibits time variation that is correlated with periods of deflationary expectations. We construct embedded option explanatory variables that are statistically and economically significant for explaining future inflation, even in the presence of traditional inflation variables such as lagged inflation, the gold return, the crude oil return, the VIX return, liquidity, surveys, and the yield spread between nominal Treasuries and TIPS. After conducting robustness tests, we conclude that the TIPS embedded option contains useful information for future inflation.     

A PRIMAL–DUAL ALGORITHM FOR BSDES

We generalize the primal–dual methodology, which is popular in the pricing of early‐exercise options, to a backward dynamic programming equation associated with time discretization schemes of (reflected) backward stochastic differential equations (BSDEs). Taking as an input some approximate solution of the backward dynamic program, which was precomputed, e.g., by least‐squares Monte Carlo, this methodology enables us to construct a confidence interval for the unknown true solution of the time‐discretized (reflected) BSDE at time 0. We numerically demonstrate the practical applicability of our method in two 5‐dimensional nonlinear pricing problems where tight price bounds were previously unavailable.     

Non-founder human capital and the long-run growth and survival of high-tech ventures

This paper considers the impact of non-founder human capital on high-tech firms' long-run growth and survival. Drawing upon threshold theory, we explore how lack of access to complementary skills at different points in the life course impacts founders' thresholds for exit. We examine these factors using a unique longitudinal dataset tracking the performance and survival of a sample of UK high-tech firms over thirteen years as the firms move from youth into maturity. We find that firms that survive but do not grow are characterized by difficulty in accessing complementary managerial skills in youth, while firms that grow but subsequently exit are characterized by shortfalls of specialized complementary skills during adolescence. Firms that grow and survive do not report skills shortfalls. We discuss the implications of these resource constraints for entrepreneurs’ decisions to persist or exit through the life course.     

What’s the contingency? A proposal for bank contingent capital triggered by systemic risk

Contingent capital (coco) automatically recapitalizes the banking system during financial crises if the trigger mechanism is properly designed. We propose a dual trigger mechanism based on: (1) aggregate systemic risk in the banking system, measured using CATFIN, and (2) the individual bank’s contribution to overall systemic risk, measured using delta CoVaR. The dual trigger is highly correlated with system-wide insolvency risk and prices systemic risk. We set different triggers for banks, insurance companies and broker-dealers. Using the 99% cut-off, systemic coco issued by Lehman and Bear Stearns would have been triggered in November 2007, months prior to their actual demise.     

The impact of idiosyncratic uncertainty when investment opportunities are endogenous

This paper develops a general equilibrium model to study the impact of aggregate fluctuations in idiosyncratic volatility that incorporates the endogenous determination of investment opportunities. By making investment options more valuable, an increase in volatility encourages the creation of new investment options. I find the response of the economy to a volatility shock depends on how investment opportunities are obtained. If potential entrants are allowed to invest in new idiosyncratic technologies, thereby acquiring options for further investment, the volatility shock increases overall investment and results in an economic boom. On the other hand, if such an investment in option creation is precluded and investment opportunities are exogenously given, the volatility shock decreases aggregate investment.     

Exit and the Epistemic Quality of Voice

Debates over the relationship between exit and voice in politics have focused on the quantity of citizen voice and its effectiveness in influencing public decisions. The epistemic quality of voice, on the other hand, has received much less attention. This article uses rational choice theory to argue that public sector exit options can lead to more informed and less biased expressions of voice. Whereas voters have weak incentives to gather and process information, exit options provide sharper epistemic incentives to produce knowledge which can spill over into voting decisions. Exit can thus improve democratic competence.     

Option-Based Compensation,Corporate Investment Policy,and Stock Repurchases

Abstract:

Taking account of the business life cycle, this paper investigates the impact of the proceeds associated with stock option exercises on investment expenditures and stock repurchases. The results reveal that the proceeds associated with option exercises could add internal funds to firms and contribute to investment in research and development and capital expenditures, especially in the growth stage of a firm’s life cycle. This paper also shows the positive relationship between option proceeds and stock repurchases in the stagnant stage of that cycle. The empirical results further suggest that stock repurchases may substitute for dividends. In summary, the paper empirically demonstrates that stock options not only encourage employees to work harder, but also create more funds for the firm.     

Valuing investment projects under interest rate risk: empirical evidence from European firms

In this article, we perform an empirical investigation of the effect of the interest rate uncertainty on the valuation of investment projects. The analysis is carried out by employing a real option approach and by considering a set of firms that operate in various production sectors in the euro area. In particular, the revenues generated by the investment projects are modelled using a geometric Brownian motion, whereas the interest rate is specified as a stochastic process of Vasicek type. Moreover, using the volatility of the equity return as a proxy, the volatility of the revenues is calibrated to real firm data, while the parameters of the interest rate model are estimated by fitting the Euribor time series. To this aim, an ad hoc calibration procedure is developed which is based on the maximum likelihood principle and thus has the merit of being simple, fast and suitable for practical purposes. Our study reveals that the interest rate uncertainty reduces the valuation of investment projects. However, stochastic interest rates do not provide a substantial improvement with respect to constant interest rates, or at least the differences are not statistically significant.