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Pricing Options with Extendible Maturities: Analysis and Applications

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Author Info
 Longstaff, Francis A
Abstract

Many common types of financial contracts incorporates options with extendible maturities. This paper derives closed-form expressions for options that can be extended by the optionholder and presents a number of applications including the valuation of American options with stochastic dividends, junk bonds, and shared-equity mortgages. We also derive closed-form expressions for writer-extendible options and discuss the writer's economic incentives for extending an out-of-the-money option. We apply these results to show that corporate debtholders have a strong incentive to extend the maturity of defaulting debt if there are liquidation costs. We model and solve the debtholders' optimal extension problem and show that the possibility of an extension can induce shareholders in highly levered firms to accept negative NPV projects. Copyright 1990 by American Finance Association.

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Publisher Info
Article provided by American Finance Association in its journal Journal of Finance.

Volume (Year): 45 (1990)
Issue (Month): 3 (July)
Pages: 935-57
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Handle: RePEc:bla:jfinan:v:45:y:1990:i:3:p:935-57

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  1. Darsinos, T. & Satchell, S.E., 2002. "On the Valuation of Warrants and Executive Stock Options: Pricing Formulae for Firms with Multiple Warrants/Executive Options," Cambridge Working Papers in Economics 0218, Faculty of Economics, University of Cambridge. [Downloadable!]
  2. Marco Realdon, . "About Debt and the Option to Extend Debt Maturity," Discussion Papers 03/20, Department of Economics, University of York. [Downloadable!]
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