Get access

Options in Agency with Binary Uncertainty

Authors

  • Óscar Gutiérrez,

    1. Universidad Autónoma de Barcelona, Spain
    Search for more papers by this author
  • Vicente Salas-Fumás

    1. Universidad de Zaragoza, Spain
    Search for more papers by this author
    • The authors sincerely appreciate the comments made by Ramón Casadesús, Rafael Repullo and Fran Ruiz on earlier versions of the paper. They also gratefully acknowledge the suggestions made by an anonymous referee, and the financial support from Project MICINN-ECO2010-21393-C04-04.

Abstract

This paper uses a stylized agency model to evaluate the economic efficiency of options contracts when pay-off uncertainty is bimodal, a situation rather common when projects either ‘fail’ or ‘succeed’. We find that ‘options’ are strictly preferred to ‘stock’ (i.e. linear contracts) when output uncertainty is large, i.e. when the spread between the modes of the pay-off distribution is sufficiently high.

Ancillary