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The Value of Embedded Real Options: Evidence from Consumer Automobile Lease Contracts
Author(s) -
GIACCOTTO CARMELO,
GOLDBERG GERSON M.,
HEGDE SHANTARAM P.
Publication year - 2007
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.2007.01211.x
Subject(s) - lease , value (mathematics) , sample (material) , embedded option , automotive industry , economics , actuarial science , econometrics , option value , business , microeconomics , interest rate , finance , mathematics , statistics , engineering , chemistry , chromatography , incentive , aerospace engineering
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.