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Employee stock option-implied risk attitude under Rank-Dependent Expected Utility

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  • Bahaji, Hamza
  • Casta, Jean-François

Abstract

Probability weighting is one of the cornerstones of decision-making theories accommodating gambling preferences. This paper examines its relevance to explaining employee stock option exercise behavior. We characterized the optimal exercise policy for a representative employee with Rank-Dependent Expected Utility (RDEU) preferences. We find that the RDEU framework leads to improved predictions of empirical exercise patterns. The implications from our findings are twofold: (1) probability weighting implies an increase in stock option cost to shareholders; (2) employee exercise behavior-implied sentiment is affected by the firm's stock market risk and performance.

Suggested Citation

  • Bahaji, Hamza & Casta, Jean-François, 2016. "Employee stock option-implied risk attitude under Rank-Dependent Expected Utility," Economic Modelling, Elsevier, vol. 52(PA), pages 144-154.
    • Handle: RePEc:eee:ecmode:v:52:y:2016:i:pa:p:144-154
    DOI: 10.1016/j.econmod.2014.12.041
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