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Optimal Investment under Cost Uncertainty

Author

Listed:
  • Jerome Detemple

    (Questrom School of Business, Boston University, Boston, MA 02215, USA)

  • Yerkin Kitapbayev

    (Questrom School of Business, Boston University, Boston, MA 02215, USA)

Abstract

This paper studies the valuation of real options when the cost of investment jumps at a random time. Three valuation formulas are derived. The first expresses the value of the project in terms of a collection of knockout barrier claims. The second identifies the premium relative to a project with delayed investment right and prices its components. The last one identifies the premium/discount relative to a project with constant cost equal to the post-jump cost and prices its components. All formulas are in closed form. The behavior of optimal investment boundaries and valuation components are examined.

Suggested Citation

  • Jerome Detemple & Yerkin Kitapbayev, 2018. "Optimal Investment under Cost Uncertainty," Risks, MDPI, vol. 6(1), pages 1-19, January.
    • Handle: RePEc:gam:jrisks:v:6:y:2018:i:1:p:5-:d:128119
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    References listed on IDEAS

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    Cited by:

    1. Detemple, Jerome & Kitapbayev, Yerkin, 2020. "The value of green energy under regulation uncertainty," Energy Economics, Elsevier, vol. 89(C).
    2. Chuan-Chuan Ko & Tyrone T. Lin & Fu-Min Zeng & Chien-Yu Liu, 2018. "Optimum Technology Product Life Cycle Technology Innovation Investment-Using Compound Binomial Options," Risks, MDPI, vol. 6(3), pages 1-14, September.

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