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Valuing the flexibility of investing in security process innovations

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  • Khansa, Lara
  • Liginlal, Divakaran
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    Abstract

    In this paper, we develop a decision model of a firm's optimal strategy for investment in security process innovations (SPIs) when confronted with a sequence of malicious attacks. The model incorporates real options as a methodology to capture the flexibility embedded in such investment decisions. SPIs, when seamlessly integrated with the organization's overall business dynamics, induce organizational learning and provide the flexibility of switching to more suitable technologies as the environment of malicious attacks changes. The theoretical contribution of this paper is a mathematical model of the invest-to-learn and switching options generated upon early investment in flexible SPIs. The practical significance of the paper is the application of a binomial lattice model to approximate the continuous-time model, resulting in an easy to use decision aid for managers.

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    Bibliographic Info

    Article provided by Elsevier in its journal European Journal of Operational Research.

    Volume (Year): 192 (2009)
    Issue (Month): 1 (January)
    Pages: 216-235

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    Handle: RePEc:eee:ejores:v:192:y:2009:i:1:p:216-235

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    Web page: http://www.elsevier.com/locate/eor

    Related research

    Keywords: Information security Investment analysis Cost-benefit analysis Real options theory Dynamic programming Security process innovations;

    References

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    1. Eduardo S. Schwartz & Carlos Zozaya-Gorostiza, 2003. "Investment Under Uncertainty in Information Technology: Acquisition and Development Projects," Management Science, INFORMS, INFORMS, vol. 49(1), pages 57-70, January.
    2. Huisman, Kuno J. M. & Kort, Peter M., 2004. "Strategic technology adoption taking into account future technological improvements: A real options approach," European Journal of Operational Research, Elsevier, Elsevier, vol. 159(3), pages 705-728, December.
    3. Pennings, Enrico & Lint, Onno, 2000. "Market entry, phased rollout or abandonment? A real option approach," European Journal of Operational Research, Elsevier, Elsevier, vol. 124(1), pages 125-138, July.
    4. Giacometti, Rosella & Teocchi, Mariangela, 2005. "On pricing of credit spread options," European Journal of Operational Research, Elsevier, Elsevier, vol. 163(1), pages 52-64, May.
    5. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, Elsevier, vol. 5(2), pages 147-175, November.
    6. Lenos Trigeorgis, 1993. "Real Options and Interactions With Financial Flexibility," Financial Management, Financial Management Association, Financial Management Association, vol. 22(3), Fall.
    7. Grenadier, Steven R. & Weiss, Allen M., 1997. "Investment in technological innovations: An option pricing approach," Journal of Financial Economics, Elsevier, Elsevier, vol. 44(3), pages 397-416, June.
    8. Alberto Moel, 2002. "When Are Real Options Exercised? An Empirical Study of Mine Closings," Review of Financial Studies, Society for Financial Studies, vol. 15(1), pages 35-64, March.
    9. Clark, Ephraim & Easaw, Joshy Z., 2007. "Optimal access pricing for natural monopoly networks when costs are sunk and revenues are uncertain," European Journal of Operational Research, Elsevier, Elsevier, vol. 178(2), pages 595-602, April.
    10. De Reyck, Bert & Degraeve, Zeger & Vandenborre, Roger, 2008. "Project options valuation with net present value and decision tree analysis," European Journal of Operational Research, Elsevier, Elsevier, vol. 184(1), pages 341-355, January.
    11. Robert G. Fichman & Chris F. Kemerer, 1997. "The Assimilation of Software Process Innovations: An Organizational Learning Perspective," Management Science, INFORMS, INFORMS, vol. 43(10), pages 1345-1363, October.
    12. Martzoukos, Spiros H. & Trigeorgis, Lenos, 2002. "Real (investment) options with multiple sources of rare events," European Journal of Operational Research, Elsevier, Elsevier, vol. 136(3), pages 696-706, February.
    13. Dangl, Thomas, 1999. "Investment and capacity choice under uncertain demand," European Journal of Operational Research, Elsevier, Elsevier, vol. 117(3), pages 415-428, September.
    14. Van Landeghem, Rik R. G., 1989. "Option analysis: Making better decision faster," European Journal of Operational Research, Elsevier, Elsevier, vol. 38(3), pages 318-328, February.
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