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On an irreversible investment problem with two-factor uncertainty

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  • F. Dammann
  • G. Ferrari

Abstract

We consider a real options model for the optimal irreversible investment problem of a profit-maximizing company. The company has the opportunity to invest in a production plant capable of producing two products, of which the prices follow two independent geometric Brownian motions. After paying a constant sunk investment cost, the company sells the products on the market and thus receives a continuous stochastic revenue flow. This investment problem is set as a two-dimensional optimal stopping problem. We find that the optimal investment decision is triggered by a convex curve, which we characterize as the unique continuous solution to a nonlinear integral equation. Furthermore, we provide analytical and numerical comparative statics results of the dependency of the project's value and investment decision with respect to the model's parameters.

Suggested Citation

  • F. Dammann & G. Ferrari, 2022. "On an irreversible investment problem with two-factor uncertainty," Quantitative Finance, Taylor & Francis Journals, vol. 22(5), pages 907-921, May.
    • Handle: RePEc:taf:quantf:v:22:y:2022:i:5:p:907-921
    DOI: 10.1080/14697688.2021.1983202
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