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Keeping Your options Open

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  • Jean Guillaume Forand

    (Department of Economics, University of Waterloo)

Abstract

In standard models of experimentation, the costs of project development consist of (a) the direct cost of running trials as well as (b)the implicit opportunity cost of leaving alternative projects idle. Another natural type of experimentation cost, the cost of holding on to the option of developing a currently inactive project, has not been studied. In a multi-armed bandit model of experimentation in which inactive projects have explicit maintenance costs and can be irreversibly discarded, I fully characterise optimal experimentation policies and show that the decision-maker's incentive to actively manage its options has important implication for the order of project development. In the model, an experimenter searches for a success among a number of projects by choosing both those to develop now and those to maintain for (potential) future development. In the absence of maintenance costs, optimal experimentation policies incentives to bring the option value of less promising projects forward, and under optimal experimentation policies, 'going -with-the-loser' can be optimal: projects that are less likely to succeed are sometimes developed rast.

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Bibliographic Info

Paper provided by University of Waterloo, Department of Economics in its series Working Papers with number 1301.

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Length: 33 pages
Date of creation: Feb 2013
Date of revision: Feb 2012
Handle: RePEc:wat:wpaper:1301

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  1. Keller, Godfrey & Rady, Sven, 2009. "Strategic Experimentation with Poisson Bandits," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 260, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
  2. Nicolas Klein & Sven Rady, 2008. "Negatively Correlated Bandits," Working Papers 040, Bavarian Graduate Program in Economics (BGPE).
  3. Cripps, Martin William & Keller, Godfrey & Rady, Sven, 2003. "Strategic Experimentation with Exponential Bandits," CEPR Discussion Papers 3814, C.E.P.R. Discussion Papers.
  4. Banks, Jeffrey S & Sundaram, Rangarajan K, 1994. "Switching Costs and the Gittins Index," Econometrica, Econometric Society, vol. 62(3), pages 687-94, May.
  5. Banks, J.s. & Sunderam, R.K., 1991. "Denumerable-Armed Bandits," RCER Working Papers 277, University of Rochester - Center for Economic Research (RCER).
  6. Dirk Bergemann & Juuso Vaimaki, 1999. "Stationary Multi Choice Bandit Problems," Cowles Foundation Discussion Papers 1240, Cowles Foundation for Research in Economics, Yale University.
  7. R. Preston Mcafee & Hugo M. Mialon & Sue H. Mialon, 2010. "Do Sunk Costs Matter?," Economic Inquiry, Western Economic Association International, vol. 48(2), pages 323-336, 04.
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Cited by:
  1. Alejandro Francetich, 2014. "Experimentation With Menus," Working Papers 516, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.

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