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How to design down-and-out barrier option contracts so that firms invest when it is socially efficient

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  • Jyh-Bang Jou
  • Tan (Charlene) Lee

Abstract

This paper investigates how to design down-and-out barrier options contracts so as firms invest when it is socially efficient. A government initially offers a firm a privileged right to exercise an investment opportunity that exhibits external benefits to society, but will eliminate this opportunity if its prospects are sufficiently bleak. The firm will invest at the date further away from that is socially efficient if the firm either is less uncertain about the return of the investment or incurs lower investment costs, or the government owns a more valuable knock-out option. Consequently, under these three scenarios the government can efficiently either offer the firm a higher investment tax credit or impose the firm a higher lease fee for holding the option to invest.

Suggested Citation

  • Jyh-Bang Jou & Tan (Charlene) Lee, 2016. "How to design down-and-out barrier option contracts so that firms invest when it is socially efficient," The European Journal of Finance, Taylor & Francis Journals, vol. 22(15), pages 1561-1579, December.
    • Handle: RePEc:taf:eurjfi:v:22:y:2016:i:15:p:1561-1579
    DOI: 10.1080/1351847X.2015.1040169
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