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Investment Timing Under Regime Switching

Author

Listed:
  • ROBERT J. ELLIOTT

    (Haskayne School of Business, University of Calgary, Calgary, AB T2N1N4, Canada;
    School of Mathematics, University of Adelaide, Adelaide, SA 5005, Australia)

  • HONG MIAO

    (Finance and Real Estate Department, Colarado State University, Fort Collins, CO 80523, USA)

  • JIN YU

    (Vienna Graduate School of Finance, Heiligenstaedter Strasse 46–48, 1190 Vienna, Austria)

Abstract

We investigate the optimal investment timing strategy in a real option framework. Depending on the state of the economy, whose changes are modeled by a Markov chain, the investment cost can take one of two values. The optimal investment timing decision is determined by finding the free boundary of a perpetual American option. Three investment timing policies, based on different assumptions of investors' information sets, are determined and compared. In the full information case, a significantly earlier optimal exercising time is indicated. We show that an optimal-timing policy suggested by the conventional real option model might ruin the investment opportunities.

Suggested Citation

  • Robert J. Elliott & Hong Miao & Jin Yu, 2009. "Investment Timing Under Regime Switching," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 12(04), pages 443-463.
    • Handle: RePEc:wsi:ijtafx:v:12:y:2009:i:04:n:s0219024909005361
    DOI: 10.1142/S0219024909005361
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    Citations

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    Cited by:

    1. Jeon, Haejun & Nishihara, Michi, 2015. "The effects of business cycle and debt maturity on a firm's investment and default decisions," International Review of Economics & Finance, Elsevier, vol. 38(C), pages 326-351.
    2. Ali Al-Aradi & Alvaro Cartea & Sebastian Jaimungal, 2018. "Technical Uncertainty in Real Options with Learning," Papers 1803.05831, arXiv.org, revised Jul 2018.
    3. Jeon, Haejun & Nishihara, Michi, 2014. "Macroeconomic conditions and a firm’s investment decisions," Finance Research Letters, Elsevier, vol. 11(4), pages 398-409.
    4. Guglielmo D’Amico & Giovanni Villani, 2021. "Valuation of R&D compound option using Markov chain approach," Annals of Finance, Springer, vol. 17(3), pages 379-404, September.

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