Investor Valuation of the Abandonment Option

51 Pages Posted: 11 Nov 2008

See all articles by Peter Berger

Peter Berger

University of Pennsylvania - The Wharton School

Eli Ofek

New York University (NYU) - Department of Finance

Itzhak Swary

affiliation not provided to SSRN

Date Written: January 1995

Abstract

We investigate whether investors price and the real option to abandon the firm for its liquidation value. Theory prices this real option as an American put with both a stochastic strike price (liquidation value) and a stochastic value of the underlying security (the value of cash flows). The major empirical implications are that firm value increases in liquidation value, after controlling for expected going-concern cash flows, and that more generalizable assets produce more abandonment option value. We use both discounted analyst forecasts of future earnings and industry-median cash flow multipliers to proxy for expected going-concern cash flows, and we rely on prior literature to categorize assets as more or less specialized. Using these measures, we find strong support for the major empirical predictions of abandonment put option theory.

Suggested Citation

Berger, Peter and Ofek, Eli and Swary, Itzhak, Investor Valuation of the Abandonment Option (January 1995). NYU Working Paper No. FIN-94-014. Available at SSRN: https://ssrn.com/abstract=1298828

Peter Berger

University of Pennsylvania - The Wharton School

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Eli Ofek

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Itzhak Swary

affiliation not provided to SSRN

No Address Available

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