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Irreversible Decisions and Record-Setting News Principles

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  • Svetlana Boyarchenko

Abstract

In the now-classical real options theory, the price of an underlying asset is modeled as a geometric Brownian motion, and optimal exercise strategies are described by simple explicit formulas. This paper extends the classical theory to allow any geometric Le´vy process to model prices. Such processes may account for fat tails and skewness of probability distributions of commodity prices. The optimal exercise strategies are specified in the paper in terms of statistics of record-setting low or high prices. The formulas derived extend those observed in the Gaussian case, but the form of the result is novel even for that case.

Suggested Citation

  • Svetlana Boyarchenko, 2004. "Irreversible Decisions and Record-Setting News Principles," American Economic Review, American Economic Association, vol. 94(3), pages 557-568, June.
  • Handle: RePEc:aea:aecrev:v:94:y:2004:i:3:p:557-568 Note: DOI: 10.1257/0002828041464452
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    References listed on IDEAS

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    1. Angus Deaton & Guy Laroque, 1992. "On the Behaviour of Commodity Prices," Review of Economic Studies, Oxford University Press, pages 1-23.
    2. Andrew B. Abel & Avinash K. Dixit & Janice C. Eberly & Robert S. Pindyck, 1996. "Options, the Value of Capital, and Investment," The Quarterly Journal of Economics, Oxford University Press, pages 753-777.
    3. 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.
    4. Ben S. Bernanke, 1983. "Irreversibility, Uncertainty, and Cyclical Investment," The Quarterly Journal of Economics, Oxford University Press, vol. 98(1), pages 85-106.
    5. Boyarchenko Svetlana & Levendorsky Sergey, 1998. "Models of Investment under Uncertainty when Shocks are Non-Gaussian. On the Impact of the Policy Uncertainty on Investment," EERC Working Paper Series 98-02e, EERC Research Network, Russia and CIS.
    6. Seung-Ryong Yang & B. Wade Brorsen, 1992. "Nonlinear Dynamics of Daily Cash Prices," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 74(3), pages 706-715.
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    Citations

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    Cited by:

    1. Ferrari, Giorgio & Salminen, Paavo, 2016. "Irreversible Investment under Lévy Uncertainty: an Equation for the Optimal Boundary," Center for Mathematical Economics Working Papers 530, Center for Mathematical Economics, Bielefeld University.
    2. Boyarchenko, Svetlana & Levendorskii[caron], Sergei, 2007. "Optimal stopping made easy," Journal of Mathematical Economics, Elsevier, vol. 43(2), pages 201-217, February.
    3. Tarun Sabarwal, 2005. "The non-neutrality of debt in investment timing: a new NPV rule," Annals of Finance, Springer, vol. 1(4), pages 433-445, October.
    4. Michi Nishihara & Takashi Sshibata, 2011. "Investment timing with fixed and proportional costs of external financing," Discussion Papers in Economics and Business 11-29, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP).
    5. Svetlana Boyarchenko & Sergei Levendorskii, 2005. "Practical guide to real options in discrete time II," Finance 0501014, EconWPA.
    6. Svetlana Boyarchenko & Sergei Levendorskii, 2005. "A theory of endogenous time preference, and discounted utility anomalies," Microeconomics 0506005, EconWPA.
    7. Svetlana Boyarchenko & Sergei Levendorski&icaron;, 2007. "Practical Guide To Real Options In Discrete Time," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 48(1), pages 311-342, February.
    8. Rainer Andergassen & Luigi Sereno, 2012. "Valuation of N-stage Investments Under Jump-Diffusion Processes," Computational Economics, Springer;Society for Computational Economics, vol. 39(3), pages 289-313, March.
    9. Luis H. R. Alvarez & Teppo A. Rakkolainen, 2006. "A Class of Solvable Optimal Stopping Problems of Spectrally Negative Jump Diffusions," Discussion Papers 9, Aboa Centre for Economics.
    10. Giorgio Ferrari & Paavo Salminen, 2014. "Irreversible Investment under L\'evy Uncertainty: an Equation for the Optimal Boundary," Papers 1411.2395, arXiv.org.
    11. Boyarchenko Svetlana & Levendorskii Sergei Z, 2006. "General Option Exercise Rules, with Applications to Embedded Options and Monopolistic Expansion," The B.E. Journal of Theoretical Economics, De Gruyter, pages 1-51.
    12. Svetlana Boyarchenko & Sergei Levendorskii, 2004. "Real options and the universal bad news principle," Levine's Bibliography 122247000000000430, UCLA Department of Economics.
    13. Luis Alvarez & Teppo Rakkolainen, 2010. "Investment timing in presence of downside risk: a certainty equivalent characterization," Annals of Finance, Springer, vol. 6(3), pages 317-333, July.
    14. Luis Alvarez & Teppo Rakkolainen, 2009. "Optimal payout policy in presence of downside risk," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 69(1), pages 27-58, March.
    15. repec:spr:compst:v:69:y:2009:i:1:p:27-58 is not listed on IDEAS
    16. Svetlana Boyarchenko & Sergei Levendorskii, 2005. "Discount factors ex post and ex ante, and discounted utility anomalies," Microeconomics 0510013, EconWPA, revised 13 Dec 2005.
    17. Clapp, John M. & Salavei, Katsiaryna, 2010. "Hedonic pricing with redevelopment options: A new approach to estimating depreciation effects," Journal of Urban Economics, Elsevier, vol. 67(3), pages 362-377, May.
    18. Svetlana Boyarchenko & Sergei Levendorskii, 2005. "American options: the EPV pricing model," Annals of Finance, Springer, vol. 1(3), pages 267-292, August.
    19. Oscar Gutiérrez, 2005. "Real options and the Jorgensonian user cost of capital," Investigaciones Economicas, Fundación SEPI, vol. 29(3), pages 625-630, September.
    20. Frank Riedel & Xia Su, 2011. "On irreversible investment," Finance and Stochastics, Springer, vol. 15(4), pages 607-633, December.
    21. Svetlana Boyarchenko, 2005. "Buridan's Ass and a Menu of Options," Game Theory and Information 0501006, EconWPA, revised 13 Dec 2005.
    22. Davis, Graham A. & Cairns, Robert D., 2012. "Good timing: The economics of optimal stopping," Journal of Economic Dynamics and Control, Elsevier, vol. 36(2), pages 255-265.
    23. Cerqueti Roy & Ventura Marco, 2015. "Patent Valuation under Spatial Point Processes with Delayed and Decreasing Jump Intensity," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 15(2), pages 433-456, July.
    24. Boyarchenko, Svetlana & Levendorskii, Sergei, 2008. "Exit problems in regime-switching models," Journal of Mathematical Economics, Elsevier, vol. 44(2), pages 180-206, January.
    25. Boyarchenko, Svetlana & Levendorskii, Sergei, 2010. "Optimal stopping in Levy models, for non-monotone discontinuous payoffs," MPRA Paper 27999, University Library of Munich, Germany.

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