IDEAS home Printed from https://ideas.repec.org/a/eee/dyncon/v92y2018icp69-83.html
   My bibliography  Save this article

Hysteresis due to irreversible exit: Addressing the option to mothball

Author

Listed:
  • Guerra, Manuel
  • Kort, Peter
  • Nunes, Cláudia
  • Oliveira, Carlos

Abstract

This paper analyses the following hitherto understudied feature in real switching options: a firm has a mothballing option and an option to permanently abandon. If the firm finds itself in an operating mode with a price just above the abandonment threshold, it is unclear whether to exercise the abandonment option or to exercise the mothballing option. If the price goes down, the firm may exit, but, surprisingly, if it goes up, it may mothball. We find that two different strategies could be optimal: one where mothballing is not a viable option and one where mothballing does occur. In the latter case a hysteresis region arises in which the firm produces at a loss, while a further price decrease induces exit and a sufficient price increase results in the firm entering the mothballing stage. Mothballing being optimal requires sufficiently large values of the price trend and the uncertainty parameter.

Suggested Citation

  • Guerra, Manuel & Kort, Peter & Nunes, Cláudia & Oliveira, Carlos, 2018. "Hysteresis due to irreversible exit: Addressing the option to mothball," Journal of Economic Dynamics and Control, Elsevier, vol. 92(C), pages 69-83.
    • Handle: RePEc:eee:dyncon:v:92:y:2018:i:c:p:69-83
    DOI: 10.1016/j.jedc.2018.04.009
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0165188918301295
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jedc.2018.04.009?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Elena Cefis & Orietta Marsili, 2011. "Born to flip. Exit decisions of entrepreneurial firms in high-tech and low-tech industries," Journal of Evolutionary Economics, Springer, vol. 21(3), pages 473-498, August.
    2. Jean-Paul Décamps & Thomas Mariotti & Stéphane Villeneuve, 2006. "Irreversible investment in alternative projects," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 28(2), pages 425-448, June.
    3. Lucija Muehlenbachs, 2015. "A Dynamic Model Of Cleanup: Estimating Sunk Costs In Oil And Gas Production," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 56, pages 155-185, February.
    4. Farzin, Y. H. & Huisman, K. J. M. & Kort, P. M., 1998. "Optimal timing of technology adoption," Journal of Economic Dynamics and Control, Elsevier, vol. 22(5), pages 779-799, May.
    5. Roger Adkins & Dean Paxson, 2016. "Subsidies for Renewable Energy Facilities under Uncertainty," Manchester School, University of Manchester, vol. 84(2), pages 222-250, March.
    6. Paul D. Childs & Timothy J. Riddiough & Alexander J. Triantis, 1996. "Mixed Uses and the Redevelopment Option," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 24(3), pages 317-339, September.
    7. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-157, April.
    8. Majd, Saman & Pindyck, Robert S., 1987. "Time to build, option value, and investment decisions," Journal of Financial Economics, Elsevier, vol. 18(1), pages 7-27, March.
    9. Bar-Ilan, Avner & Strange, William C., 1999. "The Timing and Intensity of Investment," Journal of Macroeconomics, Elsevier, vol. 21(1), pages 57-77, January.
    10. Chronopoulos, Michail & De Reyck, Bert & Siddiqui, Afzal, 2011. "Optimal investment under operational flexibility, risk aversion, and uncertainty," European Journal of Operational Research, Elsevier, vol. 213(1), pages 221-237, August.
    11. Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 101(4), pages 707-727.
    12. Bar-Ilan, Avner & Strange, William C, 1996. "Investment Lags," American Economic Review, American Economic Association, vol. 86(3), pages 610-622, June.
    13. Hagspiel, Verena & Huisman, Kuno J.M. & Kort, Peter M. & Nunes, Cláudia, 2016. "How to escape a declining market: Capacity investment or Exit?," European Journal of Operational Research, Elsevier, vol. 254(1), pages 40-50.
    14. Dixit, Avinash K, 1989. "Entry and Exit Decisions under Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 620-638, June.
    15. Sødal, Sigbjørn & Koekebakker, Steen & Aadland, Roar, 2008. "Market switching in shipping -- A real option model applied to the valuation of combination carriers," Review of Financial Economics, Elsevier, vol. 17(3), pages 183-203, August.
    16. Boomsma, Trine Krogh & Meade, Nigel & Fleten, Stein-Erik, 2012. "Renewable energy investments under different support schemes: A real options approach," European Journal of Operational Research, Elsevier, vol. 220(1), pages 225-237.
    17. Boomsma, Trine Krogh & Linnerud, Kristin, 2015. "Market and policy risk under different renewable electricity support schemes," Energy, Elsevier, vol. 89(C), pages 435-448.
    18. K. Min & Chenlu Lou & Chung-Hsiao Wang, 2012. "An Exit and Entry Study of Renewable Power Producers: A Real Options Approach," The Engineering Economist, Taylor & Francis Journals, vol. 57(1), pages 55-75.
    19. Dean Paxson, 2005. "Multiple State Property Options," The Journal of Real Estate Finance and Economics, Springer, vol. 30(4), pages 341-368, June.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Adkins, Roger & Paxson, Dean, 2019. "Rescaling-contraction with a lower cost technology when revenue declines," European Journal of Operational Research, Elsevier, vol. 277(2), pages 574-586.
    2. Alexandra Moura & Carlos Oliveira, 2024. "Reputation risk mitigation in investment strategies," Working Papers REM 2024/0309, ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa.
    3. Faninam, Farzan, 2024. "Essays on real options : Triopoly dynamics, disconnected investment regions, and multiple investment options," Other publications TiSEM cccc1cad-2899-4b57-9d83-f, Tilburg University, School of Economics and Management.
    4. Comincioli, Nicola & Hagspiel, Verena & Kort, Peter M. & Menoncin, Francesco & Miniaci, Raffaele & Vergalli, Sergio, 2021. "Mothballing in a Duopoly: Evidence from a (Shale) Oil Market," Energy Economics, Elsevier, vol. 104(C).
    5. Michi Nishihara & Takashi Shibata, 2019. "The effects of asset liquidity on dynamic bankruptcy decisions," Discussion Papers in Economics and Business 19-12, Osaka University, Graduate School of Economics.
    6. Nishihara, Michi & Shibata, Takashi, 2021. "The effects of asset liquidity on dynamic sell-out and bankruptcy decisions," European Journal of Operational Research, Elsevier, vol. 288(3), pages 1017-1035.
    7. Oliveira, Carlos & Perkowski, Nicolas, 2020. "Optimal investment decision under switching regimes of subsidy support," European Journal of Operational Research, Elsevier, vol. 285(1), pages 120-132.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Joachim Gahungu and Yves Smeers, 2012. "A Real Options Model for Electricity Capacity Expansion," RSCAS Working Papers 2012/08, European University Institute.
    2. GAHUNGU, Joachim & SMEERS, Yves, 2011. "A real options model for electricity capacity expansion," LIDAM Discussion Papers CORE 2011044, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    3. Sendstad, Lars Hegnes & Chronopoulos, Michail, 2020. "Sequential investment in renewable energy technologies under policy uncertainty," Energy Policy, Elsevier, vol. 137(C).
    4. 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.
    5. Taschini, Luca, 2021. "Flexibility premium of emissions permits," Journal of Economic Dynamics and Control, Elsevier, vol. 126(C).
    6. Kang, Sang Baum & Létourneau, Pascal, 2016. "Investors’ reaction to the government credibility problem: A real option analysis of emission permit policy risk," Energy Economics, Elsevier, vol. 54(C), pages 96-107.
    7. Adkins, Roger & Paxson, Dean, 2019. "Rescaling-contraction with a lower cost technology when revenue declines," European Journal of Operational Research, Elsevier, vol. 277(2), pages 574-586.
    8. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    9. Letifi, N. & Prigent, J.-L., 2014. "On the optimality of funding and hiring/firing according to stochastic demand: The role of growth and shutdown options," Economic Modelling, Elsevier, vol. 40(C), pages 410-422.
    10. Michi Nishihara, 2022. "Corporate sustainability, investment, and capital structure," Discussion Papers in Economics and Business 22-05, Osaka University, Graduate School of Economics.
    11. Gkochari, Christiana C., 2015. "Optimal investment timing in the dry bulk shipping sector," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 79(C), pages 102-109.
    12. Akamatsu, Takashi & Nagae, Takeshi, 2011. "A network of options: Evaluating complex interdependent decisions under uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 35(5), pages 714-729, May.
    13. Barbosa, Luciana & Ferrão, Paulo & Rodrigues, Artur & Sardinha, Alberto, 2018. "Feed-in tariffs with minimum price guarantees and regulatory uncertainty," Energy Economics, Elsevier, vol. 72(C), pages 517-541.
    14. Barbosa, Luciana & Nunes, Cláudia & Rodrigues, Artur & Sardinha, Alberto, 2020. "Feed-in tariff contract schemes and regulatory uncertainty," European Journal of Operational Research, Elsevier, vol. 287(1), pages 331-347.
    15. Sodal, Sigbjorn, 2006. "Entry and exit decisions based on a discount factor approach," Journal of Economic Dynamics and Control, Elsevier, vol. 30(11), pages 1963-1986, November.
    16. Jukka Lempa, 2020. "Some results on optimal stopping under phase-type distributed implementation delay," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 91(3), pages 559-583, June.
    17. Bar-Ilan, Avner & Strange, William C., 1998. "A model of sequential investment," Journal of Economic Dynamics and Control, Elsevier, vol. 22(3), pages 437-463, March.
    18. Tsekrekos, Andrianos E., 2010. "The effect of mean reversion on entry and exit decisions under uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 34(4), pages 725-742, April.
    19. Kort, Peter M. & Murto, Pauli & Pawlina, Grzegorz, 2010. "Uncertainty and stepwise investment," European Journal of Operational Research, Elsevier, vol. 202(1), pages 196-203, April.
    20. Bolton, Patrick & Wang, Neng & Yang, Jinqiang, 2019. "Investment under uncertainty with financial constraints," Journal of Economic Theory, Elsevier, vol. 184(C).

    More about this item

    Keywords

    Real options; Mothballing; Exit; Hysteresis;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D25 - Microeconomics - - Production and Organizations - - - Intertemporal Firm Choice: Investment, Capacity, and Financing
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:dyncon:v:92:y:2018:i:c:p:69-83. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jedc .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.