Employee Stock Option-Implied Risk Attitude Under Rank-Dependent Expected Utility

30 Pages Posted: 4 Oct 2014 Last revised: 20 Dec 2015

Hamza Bahaji

University of Paris 9 Dauphine, DRM-Finance; NATIXIS Asset Management

Jean-Francois Casta

University Paris-Dauphine - DRM Finance

Date Written: August 2, 2013

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.

Keywords: Stock options, Exercise behavior, Probability weighting, Employee sentiment

JEL Classification: G13, G30, J33, M41

Suggested Citation

Bahaji, Hamza and Casta, Jean-Francois, Employee Stock Option-Implied Risk Attitude Under Rank-Dependent Expected Utility (August 2, 2013). Economic Modelling, Vol. 52, pp.144-154.. Available at SSRN: https://ssrn.com/abstract=2504555 or http://dx.doi.org/10.2139/ssrn.2504555

Hamza Bahaji (Contact Author)

University of Paris 9 Dauphine, DRM-Finance ( email )

Place du Maréchal de Lattre de Tassigny
Cedex 16
Paris, 75775
France
00 33 6 10 30 03 67 (Phone)

NATIXIS Asset Management ( email )

21 Quai d'Austerlitz
Paris, 75013
France
0033178403633 (Phone)

Jean-Francois Casta

University Paris-Dauphine - DRM Finance ( email )

Place du Maréchal de Lattre de Tassigny
Paris, 75775
France

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