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Investment Decisions with Two-Factor Uncertainty

Author

Listed:
  • Tine Compernolle

    (Department of Engineering Management, University of Antwerp, 2000 Antwerp, Belgium
    Geological Survey of Belgium, Royal Belgian Institute of Natural Sciences, 1000 Brussels, Belgium)

  • Kuno J. M. Huisman

    (Department of Econometrics and Operations Research, Tilburg University, 5000 LE Tilburg, The Netherlands
    ASML Netherlands B.V., 5500 AH Veldhoven, The Netherlands)

  • Peter M. Kort

    (Department of Econometrics and Operations Research, Tilburg University, 5000 LE Tilburg, The Netherlands)

  • Maria Lavrutich

    (Department of Industrial Economics and Technology Management, Norwegian University of Science and Technology, 7491 Trondheim, Norway)

  • Cláudia Nunes

    (Department of Mathematics and CEMAT, Instituto Superior Técnico, 1049-001 Lisbon, Portugal)

  • Jacco J. J. Thijssen

    (Department of Mathematics, University of York, York YO10 5DD, UK)

Abstract

This paper considers investment problems in real options with non-homogeneous two-factor uncertainty. We derive some analytical properties of the resulting optimal stopping problem and present a finite difference algorithm to approximate the firm’s value function and optimal exercise boundary. An important message in our paper is that the frequently applied quasi-analytical approach underestimates the impact of uncertainty. This is caused by the fact that the quasi-analytical solution does not satisfy the partial differential equation that governs the value function. As a result, the quasi-analytical approach may wrongly advise to invest in a substantial part of the state space.

Suggested Citation

  • Tine Compernolle & Kuno J. M. Huisman & Peter M. Kort & Maria Lavrutich & Cláudia Nunes & Jacco J. J. Thijssen, 2021. "Investment Decisions with Two-Factor Uncertainty," JRFM, MDPI, vol. 14(11), pages 1-17, November.
    • Handle: RePEc:gam:jjrfmx:v:14:y:2021:i:11:p:534-:d:674627
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    References listed on IDEAS

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    Cited by:

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    2. Dammann, Felix & Ferrari, Giorgio, 2021. "On an Irreversible Investment Problem with Two-Factor Uncertainty," Center for Mathematical Economics Working Papers 646, Center for Mathematical Economics, Bielefeld University.
    3. Esparcia, Carlos & Jareño, Francisco & Umar, Zaghum, 2022. "Revisiting the safe haven role of Gold across time and frequencies during the COVID-19 pandemic," The North American Journal of Economics and Finance, Elsevier, vol. 61(C).
    4. Lorenzo Nalin & Giuliano Toshiro Yajima, 2021. "Commodities fluctuations, cross border flows and financial innovation: A stock‐flow analysis," Metroeconomica, Wiley Blackwell, vol. 72(3), pages 539-579, July.
    5. Felix Dammann & Giorgio Ferrari, 2021. "On an Irreversible Investment Problem with Two-Factor Uncertainty," Papers 2103.08258, arXiv.org, revised Jul 2021.

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