American GARCH Employee Stock Option Valuation

42 Pages Posted: 26 Feb 2008

See all articles by Angel Leon

Angel Leon

affiliation not provided to SSRN

Antoni Vaello-Sebastià

University of the Balearic Islands

Date Written: January 2, 2008

Abstract

We implement a new and flexible simulation based approach for the fair value of Employee Stock Option (ESO) plans to value American options in order to consider the common ESO characteristics of vesting period, departure risk and voluntary suboptimal early exercise. We introduce GARCH effects on the underlying asset and we analyze the price bias with respect to the constant volatility case. We also find a significant bias if we value the ESO using a short-memory GARCH model instead of a long-memory one. We also develop a sensitivity analysis with respect to changes in several ESO characteristics. We compare this valuation with FAS 123 method using the implicit expected life of the ESO revealing a FAS overvaluation. Finally, we value a real ESO plan providing the confidence intervals for the estimated ESO prices.

Keywords: Employee Stock Option, GARCH, Least-Squares Monte Carlo, fair value, FAS 123

JEL Classification: C15, C22, G13

Suggested Citation

Leon, Angel and Vaello-Sebastià, Antoni, American GARCH Employee Stock Option Valuation (January 2, 2008). EFA 2008 Athens Meetings, Available at SSRN: https://ssrn.com/abstract=1097494 or http://dx.doi.org/10.2139/ssrn.1097494

Angel Leon

affiliation not provided to SSRN

Antoni Vaello-Sebastià (Contact Author)

University of the Balearic Islands ( email )

Crtra. Valldemossa, km 7.5
Ed. Ramon Llull
Palma de Mallorca, Illles Balears 07122
Spain
971172024 (Phone)

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
19
Abstract Views
151
PlumX Metrics