On Optimal Output In an Option Pricing Framework

A contingent claims framework is used to examine a firm's optimal output decision, assuming that wealth maximization is an appropriate goal. Specifically, it is assumed that the Black-Scholes Option Pricing Model (1973) is a valid description of the pricing of a firm's equity. Black and Sc...

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Bibliographic Details
Published in:Journal of business finance & accounting 1988-04, Vol.15 (1), p.21-26
Main Authors: Conine Jr, Thomas E., Jensen, Oscar W., Tamarkin, Maurry
Format: Article
Language:English
Subjects:
Debt
Mathematical analysis
Maximization
Net present value
Optimal
Option pricing
Output
Pricing
Rates of return
Studies
Utility
Wealth
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Summary:A contingent claims framework is used to examine a firm's optimal output decision, assuming that wealth maximization is an appropriate goal. Specifically, it is assumed that the Black-Scholes Option Pricing Model (1973) is a valid description of the pricing of a firm's equity. Black and Scholes were the first to observe, under some simplifying assumptions, that a company's equity can be seen as a European call option when the underlying asset is the company. In a general framework, that is, one without specification of a particular demand-price trade-off and cost structure, it is showed that: 1. a negative monotonic relationship exists between a firm's optimal output and the face value of its debt, 2. a positive monotonic relationship exists between a firm's optimal output and the risk-free rate, and 3. an ambiguous relationship exists between a firm's optimal output and the maturity of its debt.
ISSN:0306-686X
1468-5957
DOI:10.1111/j.1468-5957.1988.tb00117.x