The Value of Embedded Real Options : Evidence from Consumer Automobile Lease Contracts - A Note

In a recent article, Giaccotto, Goldberg, and Hedge (2007) provide a simple model for pricing the cancellation and the purchase options typically embedded in automobile lease contracts, assuming constant interest rates. They show that the cancellation option is worthless because of a penalty applied if the lease is terminated before maturity. We develop a model with stochastic interest rates, to show that the cancellation option generally has a significant value also in presence of the penalty and provide sufficient conditions to make the cancellation option worthless also in a stochastic term structure setting. This extends Giaccotto, Goldberg, and Hedge (2007) results to a more general framework