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The Pricing of Risk and Sentiment: A Study of Executive Stock Options


  • Charles Chang,

  • Li-jiun Chen,

  • Cheng-der Fuh

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    • Charles Chang is an Associate Professor at the Shanghai Advanced Institute of Finance and an Adjunct Associate Professor of Finance at the Chinese University of Hong Kong. Li-jiun Chen is a Post Doctorate at the National Central University in Chungli, Taiwan. Cheng-der Fuh is a Professor of Statistics at the National Central University in Chungli, Taiwan.

  • We would like to take this opportunity to thank Bill Christie (Editor) and an anonymous referee for excellent comments that helped to shape and refine this work. We are also grateful to seminar participants at the National Taiwan University and Peking University finance seminars as well as at the Financial Engineering and Risk Management International Symposium, and the Conference on Statistical Models and Methods in Quantitative Finance and Related Topics for helpful discourse. This work would not have been possible without the early research assistance of Ya-hui Hsu and the support of National Science Council (Taiwan) grants NSC 99-2811-M-008-031 (Chang), NSC 100-2811-M-008-069 (Chen), and NSC101-3113-P-008-005 and NSC 100-2118-M-008-002-MY3 (Fuh). All remaining errors are ours.


Option pricing models accounting for illiquidity generally imply the options are valued at a discount to the Black-Scholes value. Our model considers the role of sentiment, which offsets illiquidity. Using executive stock options and compensation data from 1992 to 2004 for S&P 1500 firms, we find that executives value employee stock options (ESOs) at a 48% premium to the Black-Scholes value. These premia are explained by a sentiment level of 12% in risk-adjusted, annualized return, suggesting a high level of executive overconfidence. Subjective value relates negatively to illiquidity and idiosyncratic risk, and positively to sentiment in all specifications, consistent with the offsetting roles of sentiment and risk aversion.