WORKING PAPER NO 10 TWO-COUNTRY STOCK-FLOW-CONSISTENT MACROECONOMICS USING A CLOSED MODEL WITHIN A DOLLAR EXCHANGE REGIME

Options are not usually granted over the total value of the firm, but over the value of the firm’s equity (i.e., the stock price). There are two ways to increase stock price volatility, and hence stock options value. The first is to take on riskier projects (i.e., to increase risk on the left-hand side of the firm's balance sheet at market values). The second is to increase leverage of the firm (i.e., to increase risk on the right-hand side of the balance sheet). If firms are at an optimal capital structure, deviations from that optimum are not value-creating and may...