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Option Exercise with Temptation

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  • Junjian Miao

    ()
    (Department of Economics, Boston University)

Abstract

This paper analyzes an agent's option exercise decision under uncertainty. The agent decides whether and when to do an irreversible activity. He is tempted by immediate grati¯cation and su®ers from self-control problems. This paper adopts the Gul and Pensendorfer self- control utility model. Unlike the time inconsistent hyperbolic discounting model, it provides an explanation of procrastination and preproperation based on time consistency. When applied to the investment and exit problems, it is shown that (i) if the project value is immediate, an investor may invest in negative NPV projects; (ii) if the production cost is immediate, a ¯rm may exit even if it makes positive net pro¯ts; and (iii) if both rewards and costs are immediate, an agent may simply follow the myopic rule which compares only the current period bene¯t and cost.

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Bibliographic Info

Paper provided by Boston University - Department of Economics in its series Boston University - Department of Economics - Working Papers Series with number WP2005-007.

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Length: 34 pages
Date of creation: Jul 2005
Date of revision:
Handle: RePEc:bos:wpaper:wp2005-007

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Keywords: self-control; temptation; procrastination; preproperation; option value;

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References

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  1. Drew Fudenberg & David K. Levine, 2004. "A Dual Self Model of Impulse Control," Harvard Institute of Economic Research Working Papers 2049, Harvard - Institute of Economic Research.
  2. Per Krusell & Anthony A Smith, Jr., 2001. "Consumption Savings Decisions with Quasi-Geometric Discounting," NajEcon Working Paper Reviews 625018000000000251, www.najecon.org.
  3. Rook, Dennis W, 1987. " The Buying Impulse," Journal of Consumer Research, University of Chicago Press, University of Chicago Press, vol. 14(2), pages 189-99, September.
  4. Matt Shum & S Esteban & E Miyagawa, 2003. "Nonlinear Pricing with Self-Control Preferences," Economics Working Paper Archive 503, The Johns Hopkins University,Department of Economics.
  5. Grenadier, Steven R. & Wang, Neng, 2007. "Investment under uncertainty and time-inconsistent preferences," Journal of Financial Economics, Elsevier, Elsevier, vol. 84(1), pages 2-39, April.
  6. Akerlof, George A, 1991. "Procrastination and Obedience," American Economic Review, American Economic Association, vol. 81(2), pages 1-19, May.
  7. Ted O'Donoghue & Matthew Rabin, 1997. "Incentives for Procrastinators," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 1181, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  8. Stefano DellaVigna & M. Daniele Paserman, 2004. "Job Search and Impatience," NBER Working Papers 10837, National Bureau of Economic Research, Inc.
  9. Ted O' Donoghue & Matthew Rabin, 2001. "Choice and Procrastination," Microeconomics, EconWPA 0012002, EconWPA.
  10. Per Krusell & Burhanettin Kuruşçu & Anthony A. Smith Jr., 2010. "Temptation and Taxation," Econometrica, Econometric Society, Econometric Society, vol. 78(6), pages 2063-2084, November.
  11. Ted O'Donoghue & Matthew Rabin, 1996. "Doing It Now or Later," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 1172, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  12. Brocas, Isabelle & Carrillo, Juan D., 2005. "A theory of haste," Journal of Economic Behavior & Organization, Elsevier, vol. 56(1), pages 1-23, January.
  13. Ayse Imrohoroglu & Selahattin Imrohoroglu & Douglas H. Joines, 2003. "Time-Inconsistent Preferences And Social Security," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 118(2), pages 745-784, May.
  14. W. Pesendorfer & F. Gul, 1999. "Self-Control and the Theory of Consumption," Princeton Economic Theory Papers, Economics Department, Princeton University 99f2, Economics Department, Princeton University.
  15. Diamond, Peter & Koszegi, Botond, 2003. "Quasi-hyperbolic discounting and retirement," Journal of Public Economics, Elsevier, vol. 87(9-10), pages 1839-1872, September.
  16. DeJong, David N. & Ripoll, Marla, 2007. "Do self-control preferences help explain the puzzling behavior of asset prices?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 54(4), pages 1035-1050, May.
  17. W. Pesendorfer & F. Gul, 1999. "Temptation and Self-Control," Princeton Economic Theory Papers, Economics Department, Princeton University 99f1, Economics Department, Princeton University.
  18. Per Krusell & Burhanettin Kuruscu & Anthony A. Smith, Jr., . "Time Orientation and Asset Prices," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 2001-13, Carnegie Mellon University, Tepper School of Business.
  19. Brocas, Isabelle & Carrillo, Juan D, 2001. " Rush and Procrastination under Hyperbolic Discounting and Interdependent Activities," Journal of Risk and Uncertainty, Springer, vol. 22(2), pages 141-64, March.
  20. Laibson, David I., 1997. "Golden Eggs and Hyperbolic Discounting," Scholarly Articles 4481499, Harvard University Department of Economics.
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Citations

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Cited by:
  1. Drew Fudenberg & David K. Levine, 2004. "A Dual Self Model of Impulse Control," Harvard Institute of Economic Research Working Papers 2049, Harvard - Institute of Economic Research.
  2. Daniel Houser & Daniel Schunk & Joachim Winter & Erte Xiao, 2010. "Temptation and commitment in the laboratory," IEW - Working Papers 488, Institute for Empirical Research in Economics - University of Zurich.
  3. Laibson, David, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 112(2), pages 443-77, May.
  4. Alice Hsiaw, 2012. "Goal-Setting and Self-Control," Working Papers, College of the Holy Cross, Department of Economics 1404, College of the Holy Cross, Department of Economics, revised Aug 2014.
  5. Tsvetanov, Tsvetan & Segerson, Kathleen, 2013. "Re-evaluating the role of energy efficiency standards: A behavioral economics approach," Journal of Environmental Economics and Management, Elsevier, vol. 66(2), pages 347-363.
  6. Bisin, Alberto & Hyndman, Kyle, 2009. "Procrastination, self-imposed deadlines and other commitment devices," MPRA Paper 16235, University Library of Munich, Germany.
  7. Klaus Nehring, 2006. "Self-Control through Second-Order Preferences," Levine's Bibliography 321307000000000391, UCLA Department of Economics.
  8. D.Dragone, 2005. "Incoerenza Dinamica ed Autocontrollo: Proposta per un'Analisi Interdisciplinare," Working Papers 549, Dipartimento Scienze Economiche, Universita' di Bologna.
  9. Tsvetan Tsvetanov & Kathleen Segerson, 2011. "Re-Evaluating the Role of Energy Efficiency Standards: A Time-Consistent Behavioral Economics Approach," Working papers 2011-24, University of Connecticut, Department of Economics.
  10. Isao Shoji & Sumei Kanehiro, 2012. "Intertemporal dynamic choice under myopia for reward and different risk tolerances," Economic Theory, Springer, vol. 50(1), pages 85-98, May.

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