Does the Model Matter? A Valuation Analysis of Employee Stock Options

Abstract:     
We present a numerical analysis of valuation models for employee stock options. In particular, we analyze the impact of the model on the resulting option prices and investigate the sensitivity of pricing differences between models with respect to changes in the parameters. We show that, for most models such as the FASB 123 model, the utility-maximizing model by Rubinstein, the Hull-White model, and a simple reference model proposed in this paper, the price reduction relative to standard options is uniquely determined by the expected life of the option. In fact, with the exception of the FASB 123 model, pricing differences are negligible if the models are calibrated to the same expected life of the option. Consequently, the application of models with several hard-to-estimate parameters such as the utility-maximizing model can be greatly simplified by this calibration approach because expected life is easier to estimate than utility parameters.

Number of Pages in PDF File: 31

Keywords: Employee stock options, option pricing, option exercise

working papers series