Option Value and Flexibility: A General Theorem with Applications
AbstractWhat is the effect of future information on today's actions? The answer may help understand, or justify, low investment in the presence of costs, a preference for holding liquid money, self-insurance or precautionary savings motives, environmental preservation and global warming abatement policies. Within a three-period model, Epstein (1980) showed that the effect of future information depends on a condition on an indirect value function. We provide the necessary and sufficient condition on the model's primitives. Furthermore, we derive a generic ambiguity result, and characterize all model specifications for which the question can be answered without ambiguity. These specifications include all classical models discussed in the literature. The paper also discusses the interpretation of the concept of flexibility in this literature.
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Bibliographic InfoPaper provided by Toulouse School of Economics (TSE) in its series TSE Working Papers with number 09-002.
Date of creation: 20 Jan 2009
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Other versions of this item:
- Francois Salanie & Nicolas Treich, 2009. "Option Value and Flexibility: A General Theorem with Applications," LERNA Working Papers 09.12.288, LERNA, University of Toulouse.
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