Estimating Marketability Discounts in Sale Restricted Options Using Compound Option Pricing Theory

Abstract

This thesis presents a method for estimating the discount for lack of marketability (DLOM) in call options which are restricted for sale. The DLOM is modeled as a put option on the restricted call option, known as a compound option, with two different approaches towards setting the strike price of the compound option. The Finnerty Approach sets an average-strike price in order to reflect the lack of any special market timing by the holder of the restricted call option. The Chaffe Approach makes no assumption on the market timing of the holder and sets the strike price equal to the market value of the underlying call option. The results show that the DLOM for a sample of four firms listed in the Swedish OMX30 index ranges from 53% to 82% with the Chaffe Approach. The Finnerty Approach predicts DLOMs from 72% to 136%. This implies the Cha↵e Approach is the better method. The results supports the firm’s choice of setting an implicit discount in the options they issue by valuing them below the market price. This is because the market price should be adjusted downwards to correctly price the risk the sale restrictions entails.