Endogenous Option Pricing
35 Pages Posted:
Date Written: December 14, 2020
We show that a dynamic model of investment and capital structure choices, where the firm faces real and financial frictions, can generate option prices and implied volatilities that are in line with those of the average optionable stock. As the balance between the fundamental economic forces that are responsible for the way options are priced is state-dependent, the model is also able to generate a wide cross-sectional dispersion in implied volatility surfaces that matches what we observe in the data.
Keywords: option pricing, leverage, growth options
JEL Classification: G00, G13, G30
Suggested Citation: Suggested Citation