Investment Timing under Incomplete Information
AbstractWe study the decision of when to invest in an indivisible project whose value is perfectly observable but driven by a parameter that is unknown to the decision maker ex ante. This problem is equivalent to an optimal stopping problem for a bivariate Markov process. Using filtering and martingale techniques, we show that the optimal investment region is characterised by a continuous and non-decreasing boundary in the value/belief state space. This generates path-dependency in the optimal investment strategy. We further show that the decision maker always benefits from an uncertain drift relative to an 'average' drift situation. However, a local study of the investment boundary reveals that the value of the option to invest is not globally increasing with respect to the volatility of the value process.
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Bibliographic InfoPaper provided by Suntory and Toyota International Centres for Economics and Related Disciplines, LSE in its series STICERD - Theoretical Economics Paper Series with number 444.
Date of creation: Jan 2003
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Web page: http://sticerd.lse.ac.uk/_new/publications/default.asp
Real options; incomplete information; optimal stopping.;
Other versions of this item:
- NEP-ALL-2003-11-23 (All new papers)
- NEP-FIN-2003-11-23 (Finance)
- NEP-RMG-2003-11-23 (Risk Management)
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