Nonlinearity, correlation and the valuation of employee stock options

Details Nonlinearity, correlation and the valuation of employee stock options Nonlinearity, correlation and the valuation of employee stock options

2005-11-09

arxiv.org/abs/math/0511234v1

Mathematics

Statistics Theory

17 pages, 8 figures

Scientific paper

We propose a discrete time algorithm for the valuation of employee stock options based on exponential indifference prices and taking into account both the possibility of partial exercise of a fraction of the options and the use of a correlated traded asset to hedge part of their risk. We determine the optimal exercise policy under this conditions and present numerical results showing how both effects can significantly change the value of the option for an employee, as well as its cost for the issuing firm.

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