Valuing employee stock options and restricted stock in th e presence of market imperfections

We develop a new technology for valuing financial assets such as employee stock options and restricted stocks. Our model takes explicit account of the non-diversification of the owner of the asset. The model is an extension of the common binomial pricing model and is relatively easy to implement. This paper explains the issues and uses a database of employee stock options to estimate the model parameters and the value of stock options grants to employees. Using our model, we find that the value of employee stock options on the grant date is approximately 50% of a plain vanilla call option calculated using the Black and Scholes formula.