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Real Options With Uncertain Maturity and Competition

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  • Kristian R. Miltersen
  • Eduardo S. Schwartz
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    Abstract

    We develop a new approach to dealing with real options problems with uncertain maturity. This type of situation is typical for R&D investments and mine or oil exploration projects. These types of projects are characterized by significant on-going investment costs until completion. Since time to completion is uncertain, the total investment costs will also be uncertain. Despite the fact that these projects include complicated American abandonment/switching options until completion and European options at completion (because of fixed final investment costs) we obtain simple closed form solutions. We apply the framework to situations in which the owner of the project has monopoly rights to the outcome of the project, and to situations in which there are two owners who simultaneously invest, but where only one of them may obtain the rights to the outcome. We expand the real options framework to incorporate game theoretic considerations, including a generalization of mixed strategies to continuous-time models in the form of abandonment intensities.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12990.

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    Date of creation: Mar 2007
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    Handle: RePEc:nbr:nberwo:12990

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    1. Robert S. Pindyck, 1992. "Investments of Uncertain Cost," NBER Working Papers 4175, National Bureau of Economic Research, Inc.
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    Cited by:
    1. Yao-Wen Hsu, 2010. "Staging of venture capital investment: a real options analysis," Small Business Economics, Springer, Springer, vol. 35(3), pages 265-281, October.
    2. Michele Moretto & Cesare Dosi, 2010. "Licences, "Use or Lose" Provisions and the Time of Investment," Working Papers, Fondazione Eni Enrico Mattei 2010.24, Fondazione Eni Enrico Mattei.

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