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An improved of Hull–White model for valuing Employee Stock Options (ESOs)

Author

Listed:
  • Erwinna Chendra

    (Institute of Technology Bandung
    Parahyangan Catholic University)

  • Kuntjoro A. Sidarto

    (Institute of Technology Bandung)

Abstract

Employee stock options (ESOs) are call options granted by a company to its employees as a means to retain and to motivate them for working towards improvement of the company’s earning and management. ESOs have unique characteristics, such as: they have long maturity time, they are not tradable, and they can be exercised only after the vesting period. All these characteristics have significant implication on the valuation of ESOs. In this paper, we improve Hull–White ESO model using Bino-Trinomial tree method. We also modify a single psychological barrier on Hull–White model with moving psychological barriers based on empirical study that the ESO’s holders require the stock price to be at relatively high to induce voluntary exercise, yet later they will exercise at relatively low stock price near the time to maturity. Numerical experiments are given to verify the robustness of the proposed model and to analyze the sensitivity with respect to the model parameters. The ESO prices become cheaper if the holders degrade their psychological barriers.

Suggested Citation

  • Erwinna Chendra & Kuntjoro A. Sidarto, 2020. "An improved of Hull–White model for valuing Employee Stock Options (ESOs)," Review of Quantitative Finance and Accounting, Springer, vol. 54(2), pages 651-669, February.
    • Handle: RePEc:kap:rqfnac:v:54:y:2020:i:2:d:10.1007_s11156-019-00802-x
    DOI: 10.1007/s11156-019-00802-x
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    References listed on IDEAS

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    More about this item

    Keywords

    Employee stock option; Hull–White ESO model; Moving psychological barriers;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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