Risk, Ambiguity, and the Exercise of Employee Stock Options

We investigate the importance of ambiguity, or Knightian uncertainty, in executives' decisions about when to exercise stock options. We develop an empirical estimate of ambiguity and include it in regression models alongside the more traditional measure of risk, equity volatility. We show that each variable has a statistically significant effect on the timing of option exercises, with volatility causing executives to hold their options longer in order to preserve remaining option value, and ambiguity increasing the tendency for executives to exercise early in response to risk aversion. Regression estimates for the volatility and ambiguity variables imply similar magnitudes of economic impact upon the exercise decision, with the volatility variable being about 2.5 times stronger.