This paper describes the relation among a variety of asset leasing contracts, including: (1) cancellable operating leases; (2) leases which grant the lesse an option to extend the life of the lease; (3) leases that grant the lessee an option to purchase the leased asset at a fixed price at the maturity date of the lease; (4) leases that grant the lessee the right to purchase the leased asset at its ‘fair market value’ at the maturity date of the lease; (5) leases that grant an option to the lessee to purchase the leased asset at a prespecified price anytime during the life of the lease; (6) leases that require the lessee to purchase the leased asset at a fixed price at the maturity date of the lease; and (7) leases that contain non-cancellation provisions. The paper uses a compound option pricing framework to develop a general model for valuing (or evaluating) each of the types of leasing contracts. Numerical examples are presented to illustrate the effect of the various elements of a leasing contract — including cancellation risk and residual value risk — on equilibrium rental payments.

This study tests hypotheses about the valuation of leasing contracts. We examine the determinants of the yields of a relatively large, reasonably heterogeneous, and nationally representative sample of financial leases. We find lease yields to be significantly related to treasury bond yields and our proxies for the systematic risk of the leased asset's residual value and the transaction and information costs associated with the lease. There is also some evidence of a relationship between lease yields and the default-risk of the lessee.