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Practical guide to real options in discrete time II

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Author Info

  • Svetlana Boyarchenko

    (The University of Texas at Austin.)

  • Sergei Levendorskii

    (The University of Texas at Austin)

Abstract

This paper is an extended version of the paper 'Practical Guide to Real Options in Discrete Time' (http://econwpa.wustl.edu:80/eps/fin/papers/0405/0405016.pdf), where a general, computationally simple approach to real options in discrete time was suggested. We explicitly formulate conditions of the general theorems for basic types of real options, and explain our method in detail for the case of transition density given by exponential functions on each half-axis. To demonstrate that the discrete time approach can be more analytically tractable than the continuous time one, we consider timing of investment with lags, and a model of gradual capital expansion. We obtain simple formulas for the expected values of capital stock in every time period; in continuous time models, a much more sophisticated technique is needed.

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File URL: http://128.118.178.162/eps/fin/papers/0501/0501014.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Finance with number 0501014.

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Length: 28 pages
Date of creation: 31 Jan 2005
Date of revision:
Handle: RePEc:wpa:wuwpfi:0501014

Note: Type of Document - pdf; pages: 28
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Web page: http://128.118.178.162

Related research

Keywords: Real options; embedded options; expected present value operators;

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References

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  1. Bar-Ilan, Avner & Strange, William C, 1996. "Investment Lags," American Economic Review, American Economic Association, vol. 86(3), pages 610-22, June.
  2. Peter Carr & Liuren Wu, 2002. "The Finite Moment Log Stable Process and Option Pricing," Finance 0207012, EconWPA.
  3. Svetlana Boyarchenko, 2001. "Capital Accumulation under Non-Gaussian Processes and the Marshallian Law," Penn CARESS Working Papers 471ab9dee66c9aa1d3ef23dd9, Penn Economics Department.
  4. 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.
  5. Svetlana Boyarchenko, 2004. "Irreversible Decisions and Record-Setting News Principles," American Economic Review, American Economic Association, vol. 94(3), pages 557-568, June.
  6. Angus Deaton & Guy Laroque, 1990. "On The Behavior of Commodity Prices," NBER Working Papers 3439, National Bureau of Economic Research, Inc.
  7. R. Glenn Hubbard, 1994. "Investment under Uncertainty: Keeping One's Options Open," Journal of Economic Literature, American Economic Association, vol. 32(4), pages 1816-1831, December.
  8. Steven J. Davis & John C. Haltiwanger & Scott Schuh, 1998. "Job Creation and Destruction," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262540932, December.
  9. Thomas F. Cooley & Vincenzo Quadrini, 2001. "Financial Markets and Firm Dynamics," American Economic Review, American Economic Association, vol. 91(5), pages 1286-1310, December.
  10. S. I. Boyarchenko & S. Z. Levendorskii, 2002. "Pricing of perpetual Bermudan options," Quantitative Finance, Taylor & Francis Journals, vol. 2(6), pages 432-442.
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