Real options and the universal bad news principle
AbstractA general framework for pricing of real options in continuous time for wide classes of payoff streams that are monotone functions of a Levy process is provided. Exercise rules are formulated in terms of statistics of record-setting low payoffs and can be viewed as an extension of Bernanke's bad news principle. To illustrate the framework, we solve analytically the following problems: a capital expansion program when the underlying price exhibits mean reverting features; an entry decision with an option to exit, and a new technology adoption. The effects of industry specific and idiosyncratic risks are separated. The third model is driven by two factors: one describes the dynamics of the frontier technology, the other incorporates non-technological uncertainty. The former factor follows a process with upward jumps. The impact of these factors on new technology adoption is analyzed.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by EconWPA in its series Finance with number 0405011.
Length: 34 pages
Date of creation: 06 May 2004
Date of revision:
Note: Type of Document - pdf; pages: 34
Contact details of provider:
Web page: http://220.127.116.11
exit and entry; emdebbed options; technology adoption; capital expansion;
Other versions of this item:
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-05-09 (All new papers)
- NEP-CFN-2004-05-09 (Corporate Finance)
- NEP-FIN-2004-05-09 (Finance)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Deaton, A. & Laroque, G., 1989.
"On The Behavior Of Commodity Prices,"
145, Princeton, Woodrow Wilson School - Public and International Affairs.
- Svetlana Boyarchenko, 2004. "Irreversible Decisions and Record-Setting News Principles," American Economic Review, American Economic Association, vol. 94(3), pages 557-568, June.
- Andrew B. Abel & Janice B. Eberly, .
"The Effects of Irreversibility and Uncertainty on Capital Accumulation,"
Rodney L. White Center for Financial Research Working Papers
21-95, Wharton School Rodney L. White Center for Financial Research.
- Abel, Andrew B. & Eberly, Janice C., 1999. "The effects of irreversibility and uncertainty on capital accumulation," Journal of Monetary Economics, Elsevier, vol. 44(3), pages 339-377, December.
- Andrew B. Abel & Janice C. Eberly, 1995. "The Effects of Irreversibility and Uncertainty on Capital Accumulation," NBER Working Papers 5363, National Bureau of Economic Research, Inc.
- Lander, Diane M. & Pinches, George E., 1998. "Challenges to the Practical Implementation of Modeling and Valuing Real Options," The Quarterly Review of Economics and Finance, Elsevier, vol. 38(3, Part 2), pages 537-567.
- Schwartz, Eduardo S, 1997. " The Stochastic Behavior of Commodity Prices: Implications for Valuation and Hedging," Journal of Finance, American Finance Association, vol. 52(3), pages 923-73, July.
- Svetlana Boyarchenko & Sergei Levendorskii, 2004. "Universal bad news principle and pricing of options on dividend-paying assets," Papers cond-mat/0404108, arXiv.org.
- Svetlana Boyarchenko & Sergey Levendorskiy, 2004.
"Optimal stopping made easy,"
- Flavia Barsotti, 2012. "Optimal Capital Structure with Endogenous Default and Volatility Risk," Working Papers - Mathematical Economics 2012-02, Universita' degli Studi di Firenze, Dipartimento di Scienze per l'Economia e l'Impresa.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (EconWPA).
If references are entirely missing, you can add them using this form.