Advanced Search
DSpace@MIT

Analysis of employee stock options and guaranteed withdrawal benefits for life

Research and Teaching Output of the MIT Community

Show simple item record

dc.contributor.advisor Dimitris J. Bertsimas. en_US
dc.contributor.author Shah, Premal (Premal Y.) en_US
dc.contributor.other Massachusetts Institute of Technology. Operations Research Center. en_US
dc.date.accessioned 2009-06-25T20:35:51Z
dc.date.available 2009-06-25T20:35:51Z
dc.date.copyright 2008 en_US
dc.date.issued 2008 en_US
dc.identifier.uri http://hdl.handle.net/1721.1/45626
dc.description Thesis (Ph. D.)--Massachusetts Institute of Technology, Sloan School of Management, Operations Research Center, 2008. en_US
dc.description This electronic version was submitted by the student author. The certified thesis is available in the Institute Archives and Special Collections. en_US
dc.description Includes bibliographical references (p. 215-224). en_US
dc.description.abstract In this thesis we study three problems related to financial modeling. First, we study the problem of pricing Employee Stock Options (ESOs) from the point of view of the issuing company. Since an employee cannot trade or eectively hedge ESOs, she exercises them to maximize a subjective criterion of value. Modeling this exercise behavior is key to pricing ESOs. We argue that ESO exercises should not be modeled on a one by one basis, as is commonly done, but at a portfolio level because exercises related to different ESOs that an employee holds would be coupled. Using utility based models we also show that such coupled exercise behavior leads to lower average ESO costs for the commonly used utility functions such as power and exponential utilities. Unfortunately, utility based models do not lead to tractable solutions for finding costs associated with ESOs. We propose a new risk management based approach to model exercise behavior based on mean-variance portfolio maximization. The resulting exercise behavior is both intuitive and leads to a computationally tractable model for finding ESO exercises and pricing ESOs as a portfolio. We also study a special variant of this risk-management based exercise model, which leads to a decoupling of the ESO exercises and then obtain analytical bounds on the implied cost of an ESO for the employer in this case. Next, we study Guaranteed Withdrawal Benefits (GWB) for life, a recent and popular product that many insurance companies have offered for retirement planning. The GWB feature promises to the investor increasing withdrawals over her lifetime and is an exotic option that bears financial and mortality related risks for the insurance company. en_US
dc.description.abstract (cont.) The GWB feature promises to the investor increasing withdrawals over her lifetime and is an exotic option that bears financial and mortality related risks for the insurance company. We first analyze a continuous time version of this product in a Black Scholes economy with simplifying assumptions on population mortality and obtain an analytical solution for the product value. This simple analysis reveals the high sensitivity the product bears to several risk factors. We then further investigate the pricing of GWB in a more realistic setting using different asset pricing models, including those that allow the interest rates and the volatility of returns to be stochastic. Our analysis reveals that 1) GWB has insufficient price discrimination and is susceptible to adverse selection and 2) valuations can vary substantially depending on which class of models is used for accounting. We believe that the ambiguity in value and the presence of significant risks, which can be challenging to hedge, should create concerns to the GWB underwriters, their clients as well as the regulators. Finally, many problems in finance are Sequential Decision Problems (SDPs) under uncertainty. We nd that SDP formulations using commonly used financial metrics or acceptability criteria can lead to dynamically inconsistent strategies. We study the link between objective functions used in SDPs, dynamic consistency and dynamic programming. We then propose ways to create dynamically consistent formulations. en_US
dc.description.statementofresponsibility by Premal Shah. en_US
dc.format.extent 224 p. en_US
dc.language.iso eng en_US
dc.publisher Massachusetts Institute of Technology en_US
dc.rights M.I.T. theses are protected by copyright. They may be viewed from this source for any purpose, but reproduction or distribution in any format is prohibited without written permission. See provided URL for inquiries about permission. en_US
dc.rights.uri http://dspace.mit.edu/handle/1721.1/7582 en_US
dc.subject Operations Research Center. en_US
dc.title Analysis of employee stock options and guaranteed withdrawal benefits for life en_US
dc.type Thesis en_US
dc.description.degree Ph.D. en_US
dc.contributor.department Massachusetts Institute of Technology. Operations Research Center. en_US
dc.identifier.oclc 320958315 en_US


Files in this item

Name Size Format Description
320958315.pdf 1.150Mb PDF Preview, non-printable (open to all)
320958315-MIT.pdf 1.145Mb PDF Full printable version (MIT only)

This item appears in the following Collection(s)

Show simple item record

MIT-Mirage