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Real Options with Priced Regime-Switching Risk

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Author Info
John Driffill
Martin Sola ()
Turalay Kenc

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Abstract

e develop a model of regime-switching risk premia as well as regimedependent factor risk premia to price real options. The model incorporates the observation that the underlying risky income streams of real options are subject to discrete shifts over time as well as random changes. The presence of discrete shifts is due to systematic and unsystematic risk associated with changes in business cycles or in economic policy regimes or events such as takeovers, major changes in business plans. We analyze the impact of regimeswitching behavior on the valuation of projects and investment opportunities. We find that accounting for Markov switching risk results in a delay in the expected timing of the investment while the regime-specific factor risk premia make the possibility of a regime shift more pronounced.

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Publisher Info
Paper provided by Universidad Torcuato Di Tella in its series Department of Economics Working Papers with number 2009-09.

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Length: 40 pages
Date of creation: Sep 2009
Date of revision:
Handle: RePEc:udt:wpecon:2009-09

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Related research
Keywords: Regime-Switching Risk Premia; Regime-Dependent Risk Premia; Real Options.;

Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy

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References listed on IDEAS
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    Other versions:
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