This paper empirically investigates the stock price dynamics implied by the valuation model proposed by Schwartz and Moon (2001) for growth companies. We test the hypothesis that the inherent stochastic process for the firm equity value better describes the actual dynamics than standard geometric Brownian motion. Because the form of the stochastic process decisively influences the values of options written on a firm’s stock, we rely on price information from the options market to test the hypothesis. Therefore, we propose an adapted version of the Least-Squares Monte Carlo algorithm to price options on the stock of a growth company whose value is determined by the Schwartz-Moon model. Calibrating the model to real-world stock and option data, we analyze the stock price dynamics implied by the Schwartz-Moon model empirically by comparing them to a standard geometric Brownian motion model. The study is conducted for three high-growth Internet companies: Amazon.com, eBay and Google. Contrary to our expectations, we find no evidence that the Schwartz-Moon model is superior in explaining the options market for growth companies. The reason is due to the Schwartz-Moon model’s restriction on specifying the volatility of revenues, which allows only for exponentially decreasing functions.

Valuing growth companies has always been challenging. Tackling this challenge, Schwartz and Moon (2000 and 2001) propose a model for the ‘rational’ valuation of growth companies. Within this model, the firm’s major value drivers are assumed to follow stochastic processes that account for the specific characteristics of high-growth companies. The firm value is derived by employing risk-neutral valuation techniques as is frequently done in the real options literature (for an overview of real options theory see, for example, Dixit and Pindyck, 1994; and Trigeorgis, 1996).

Despite the attention the Schwartz-Moon model receives in academic literature,¹ only a few papers address the adequacy of the model for describing observed stock prices. Keiber et al. (2002) test the model for growth companies listed on the German ‘Neuer Markt’. They estimate all parameters exogenously and question whether the model can explain the observed stock price. In a similar manner, Hartmann-Wendels et al. (2008) conduct an extensive study of 2,262 firms. They compare the model results to firm values based on the traditional multiples approach.

Applied Finance Journal, Stock Price, Dynamics, Listed Growth Companies, Evidence, Options Market.