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

  • Author(s): CARMELO GIACCOTTO, GERSON M. GOLDBERG, SHANTARAM P. HEGDE
  • Published: Jan 11, 2007
  • Pages: 411-445
  • DOI: 10.1111/j.1540-6261.2007.01211.x

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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