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Market pricing of executive stock options and implied risk preferences

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  • Pirjetä, Antti
  • Ikäheimo, Seppo
  • Puttonen, Vesa
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    Abstract

    When managers get to trade in options received as compensation, their trading prices reveal several aspects of subjective option pricing and risk preferences. Two subjective pricing models are fitted to show that executive stock option prices incorporate a subjective discount. It depends positively on implied volatility and negatively on option moneyness. Further, risk preferences are estimated using the semiparametric model of Aït-Sahalia and Lo (2000). The results suggest that relative risk aversion is just above 1 for a certain stock price range. This level of risk aversion is low but reasonable, and it may be explained by the typical manager being wealthy and having low marginal utility. Related to risk aversion, it is found that marginal rate of substitution increases considerably in states with low stock prices.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Empirical Finance.

    Volume (Year): 17 (2010)
    Issue (Month): 3 (June)
    Pages: 394-412

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    Handle: RePEc:eee:empfin:v:17:y:2010:i:3:p:394-412

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    Web page: http://www.elsevier.com/locate/jempfin

    Related research

    Keywords: Risk preferences Executive stock options (ESOs) Risk aversion;

    References

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    1. Manuel Santos & Jorge Aseff, . "Stock Options and Managerial Optimal Contracts," Working Papers 2133304, Department of Economics, W. P. Carey School of Business, Arizona State University.
    2. Yacine Ait-Sahalia & Andrew W. Lo, 2000. "Nonparametric Risk Management and Implied Risk Aversion," NBER Working Papers 6130, National Bureau of Economic Research, Inc.
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    8. Yaacov Z. Bergman & Bruce D. Grundy & Zvi Wiener, . "General Properties of Option Prices (Revision of 11-95) (Reprint 058)," Rodney L. White Center for Financial Research Working Papers 01-96, Wharton School Rodney L. White Center for Financial Research.
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    15. Yacine Aït-Sahalia & Andrew W. Lo, . "Nonparametric Estimation of State-Price Densities Implicit in Financial Asset Prices," CRSP working papers 332, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
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