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Employee stock option-implied risk attitude under Rank-Dependent Expected Utility

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Date
2016
Notes
Special Issue on Recent Developments in Decision-Making, Monetary Policy and Financial Markets
Dewey
Organisation et finances d'entreprise
Sujet
Stock options; Exercise behavior; Probability weighting; Employee sentiment
JEL code
G.G1.G13; G.G3.G30; J.J3.J33; M.M4.M41
Journal issue
Economic Modelling
Volume
Volume 52, Part A
Number
January
Publication date
2016
Article pages
144–154
Publisher
Elsevier
DOI
http://dx.doi.org/10.1016/j.econmod.2014.12.041
URI
https://basepub.dauphine.fr/handle/123456789/14116
Collections
  • DRM : Publications
Metadata
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Author
Bahaji, Hamza
Casta, Jean-François
Type
Article accepté pour publication ou publié
Abstract (EN)
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.

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