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An Easy-To-Use Toolkit for Solving Optimal Stopping Problems

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  • Jacco J.J. Thijssen

Abstract

This paper studies a class of optimal stopping problems that has become popular in the area of investment under uncertainty (``real options''). Necessary conditions for solutions to these problems are that the solution dominates the payoff function and is superharmonic. Neither property is typically verified in the literature. Here, easy-to-check conditions that establish solutions to many optimal stopping problems are provided. Attention is focussed on problems with payoff functions that are monotonic in the state variable (either increasing or decreasing) or payoff functions that are decreasing, then increasing. The state variable can be driven by any one-dimensional time-homogenous diffusion. An application to Bayesian sequential hypothesis testing illustrates the applicability of the approach.

Suggested Citation

  • Jacco J.J. Thijssen, 2013. "An Easy-To-Use Toolkit for Solving Optimal Stopping Problems," Discussion Papers 13/24, Department of Economics, University of York.
  • Handle: RePEc:yor:yorken:13/24
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    References listed on IDEAS

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    1. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
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    Cited by:

    1. Delaney, L., 2015. "An Examination of the Optimal Timing Strategy for a Slow Trader Investing in a High Frequency Trading Technology," Working Papers 15/04, Department of Economics, City University London.

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    More about this item

    Keywords

    Optimal stopping; Real options;

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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