Pricing an Option on a Non-Decreasing Asset Value: An Application to Movie Revenue

44 Pages Posted: 18 Dec 2005

See all articles by Don M. Chance

Don M. Chance

Louisiana State University, Baton Rouge - Department of Finance; Louisiana State University, Baton Rouge - E.J. Ourso College of Business Administration

Eric T. Hillebrand

Aarhus University

Jimmy E. Hilliard

Louisiana State University, Baton Rouge - E.J. Ourso College of Business Administration

Date Written: December 16, 2005

Abstract

In recent years financial engineers have created instruments that facilitate the efficient transfer of the risk associated with certain forms of entertainment revenues. This paper focuses on one particular instrument, options on streams of movie revenues. These options enable film distributors to manage the risk of a movie, and they offer diversification opportunities for investors. Pricing the options is complicated by the fact that cumulative revenue is zero when the options are first offered, uncertainty is high at the start and quickly diminishes, and the underlying is non-decreasing. We propose a continuous time Gamma process to capture the underlying revenue stream and derive the option pricing formula. To estimate the parameters of the process before revenue observations are available, we propose a regression method using revenue data from a data base of earlier movies. With the arrival of the revenue observations, we update the initial estimates in a Bayesian framework. The fit of the revenue process and the option price formula to movie data as well as sensitivities of the option price with respect to the parameters are explored. We apply our method to a set of example movies.

Keywords: option pricing, gamma process, risk management, movie revenues, non-decreasing process, Bayesian update

JEL Classification: C11, C22, G13, L82

Suggested Citation

Chance, Don M. and Hillebrand, Eric T. and Hilliard, Jimmy E., Pricing an Option on a Non-Decreasing Asset Value: An Application to Movie Revenue (December 16, 2005). Available at SSRN: https://ssrn.com/abstract=870793 or http://dx.doi.org/10.2139/ssrn.870793

Don M. Chance (Contact Author)

Louisiana State University, Baton Rouge - Department of Finance ( email )

2900 BEC
Baton Rouge, LA 70803
United States

Louisiana State University, Baton Rouge - E.J. Ourso College of Business Administration ( email )

Baton Rouge, LA 70803-6308
United States
225-578-0372 (Phone)
225-578-6366 (Fax)

HOME PAGE: http://www.bus.lsu.edu/academics/finance/faculty/dchance/

Eric T. Hillebrand

Aarhus University ( email )

Fuglesangs Allé 4
Aarhus V, 8210
Denmark

Jimmy E. Hilliard

Louisiana State University, Baton Rouge - E.J. Ourso College of Business Administration ( email )

Department of Finance
Baton Rouge, LA 70803-6308
United States
225-578-7676 (Phone)
225-578-6366 (Fax)

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
243
Abstract Views
1,892
Rank
228,791
PlumX Metrics