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- Title
Pricing Options with Extendible Maturities: Analysis and Applications.
- Authors
Longstaff, Francis A.
- Abstract
Many common types of financial contracts incorporate options with extendible maturities. This paper derives closed-form expressions for options that can be extended by the optionholder and presents a number of applications including the valuation of American options with stochastic dividends, junk bonds, and shared-equity mortgages. We also derive closed-form expressions for writer-extendible options and discuss the writer's economic incentives for extending an out-of-the-money option. We apply these results to show that corporate debtholders have a strong incentive to extend the maturity of defaulting debt if there are liquidation costs. We model and solve the debtholders' optimal extension problem and show that the possibility of an extension can induce shareholders in highly levered firms to accept negative NPV projects.
- Subjects
UNITED States; PRICING; OPTIONS (Finance); MATURITY (Finance); MORTGAGE bonds; DIVIDENDS; SECURITIES; JUNK bonds; CORPORATE debt; DEBT-to-equity ratio; STOCKHOLDERS equity; LIQUIDATING dividends
- Publication
Journal of Finance (Wiley-Blackwell), 1990, Vol 45, Issue 3, p935
- ISSN
0022-1082
- Publication type
Article
- DOI
10.1111/j.1540-6261.1990.tb05113.x