RT Journal Article
SR Electronic
T1 An Option-Based Model for Valuing the Common Stock of Emerging-Growth Firms
JF The Journal of Derivatives
FD Institutional Investor Journals
SP 33
OP 53
DO 10.3905/jod.2016.23.4.033
VO 23
IS 4
A1 John D. Finnerty
YR 2016
UL https://pm-research.com/content/23/4/33.abstract
AB A start-up firm launching a new technology faces what it hopes will be a period of rapid development in which the economic viability of its product and business plan will be confirmed. Once viability is established, the firm enters a period of normal growth and profitability. The claims the original stockholders possess are best described as mostly real options. Option maturity is when it becomes known whether the technology under development is either worth pursuing over the long term or, alternatively, a failure that must be abandoned. The now-familiar idea that stock can be thought of as an option on the assets of the underlying firm dates back to the early days of option-pricing theory, and it has provided the framework of the structural approach to evaluating credit risk. This article shows how the same basic approach can be used to value the common stock of an emerging-growth company. The major challenge of the procedure is how to estimate the necessary option parameters for a rapidly evolving firm with little price history. Finnerty demonstrates his approach using LinkedIn and Pacific Biosciences as case studies.TOPICS: Options, real assets/alternative investments/private equity