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The Value of Embedded Real Options: Evidence from Consumer Automobile Lease Contracts

Authors

  • CARMELO GIACCOTTO,

  • GERSON M. GOLDBERG,

  • SHANTARAM P. HEGDE

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    • Giaccotto is at the University of Connecticut. Goldberg is at the Gabelli School of Business, Roger Williams University. Hegde is at the University of Connecticut. We thank the editor, Rob Stambaugh, an associate editor, an anonymous referee, John Harding, Jonathan Curran, and seminar participants at the University of Connecticut, the University of Massachusetts, Roger Williams University, and the 2003 Financial Management Association conference in Denver for many helpful comments. All remaining errors are our responsibility.


ABSTRACT

Under the common assumption of constant interest rates, we show that penalties for early termination of a lease are often structured in such a way that the cancellation option embedded in consumer automotive leases has little value. Furthermore, our estimates drawn from a sample of three popular car models over 1990 to 2000 indicate that the stand-alone value of the lease-end purchase option is, on average, about 16% of the market value of underlying used vehicles, or about $1,462 per contract. Finally, we examine the sensitivity of our option value estimates to model parameters and default risk.

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