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Investment Timing Under Regime Switching

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  • ROBERT J. ELLIOTT

    ()
    (Haskayne School of Business, University of Calgary, Calgary, AB T2N1N4, Canada; School of Mathematics, University of Adelaide, Adelaide, SA 5005, Australia)

  • HONG MIAO

    ()
    (Finance and Real Estate Department, Colarado State University, Fort Collins, CO 80523, USA)

  • JIN YU

    ()
    (Vienna Graduate School of Finance, Heiligenstaedter Strasse 46–48, 1190 Vienna, Austria)

Abstract

We investigate the optimal investment timing strategy in a real option framework. Depending on the state of the economy, whose changes are modeled by a Markov chain, the investment cost can take one of two values. The optimal investment timing decision is determined by finding the free boundary of a perpetual American option. Three investment timing policies, based on different assumptions of investors' information sets, are determined and compared. In the full information case, a significantly earlier optimal exercising time is indicated. We show that an optimal-timing policy suggested by the conventional real option model might ruin the investment opportunities.

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Bibliographic Info

Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.

Volume (Year): 12 (2009)
Issue (Month): 04 ()
Pages: 443-463

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Handle: RePEc:wsi:ijtafx:v:12:y:2009:i:04:p:443-463

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Keywords: Regime switching; real option; investment timing;

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