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Option Exercise with Temptation

  • Junjian Miao

    ()

    (Department of Economics, Boston University)

This paper analyzes an agent's option exercise decision under uncertainty. The agent decides whether and when to do an irreversible activity. He is tempted by immediate grati¯cation and su®ers from self-control problems. This paper adopts the Gul and Pensendorfer self- control utility model. Unlike the time inconsistent hyperbolic discounting model, it provides an explanation of procrastination and preproperation based on time consistency. When applied to the investment and exit problems, it is shown that (i) if the project value is immediate, an investor may invest in negative NPV projects; (ii) if the production cost is immediate, a ¯rm may exit even if it makes positive net pro¯ts; and (iii) if both rewards and costs are immediate, an agent may simply follow the myopic rule which compares only the current period bene¯t and cost.

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Paper provided by Boston University - Department of Economics in its series Boston University - Department of Economics - Working Papers Series with number WP2005-007.

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Length: 34 pages
Date of creation: Jul 2005
Date of revision:
Handle: RePEc:bos:wpaper:wp2005-007
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  1. Rook, Dennis W, 1987. " The Buying Impulse," Journal of Consumer Research, Oxford University Press, vol. 14(2), pages 189-99, September.
  2. Per Krusell & Burhanettin Kuruscu & Anthony A. Smith, Jr., 2000. "Temptation and Taxation," GSIA Working Papers 2001-12, Carnegie Mellon University, Tepper School of Business.
  3. Ayşe İmrohoroğlu & Selahattin İmrohoroğlu & Douglas H. Joines, 2003. "Time-Inconsistent Preferences and Social Security," The Quarterly Journal of Economics, Oxford University Press, vol. 118(2), pages 745-784.
  4. Per Krusell & Anthony A. Smith, Jr., 2003. "Consumption--Savings Decisions with Quasi--Geometric Discounting," Econometrica, Econometric Society, vol. 71(1), pages 365-375, January.
  5. Matt Shum & S Esteban & E Miyagawa, 2003. "Nonlinear Pricing with Self-Control Preferences," Economics Working Paper Archive 503, The Johns Hopkins University,Department of Economics.
  6. Faruk Gul & Wolfgang Pesendorfer, 2004. "Self-Control and the Theory of Consumption," Econometrica, Econometric Society, vol. 72(1), pages 119-158, 01.
  7. O'Donoghue, Ted & Rabin, Matthew, 2000. "Choice and Procrastination," Department of Economics, Working Paper Series qt5r26k54p, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  8. DeJong, David N. & Ripoll, Marla, 2007. "Do self-control preferences help explain the puzzling behavior of asset prices?," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1035-1050, May.
  9. Per Krusell & Burhanettin Kuruscu & Anthony A. Smith, Jr., . "Time Orientation and Asset Prices," GSIA Working Papers 2001-13, Carnegie Mellon University, Tepper School of Business.
  10. Matthew Rabin & Ted O'Donoghue, 1999. "Doing It Now or Later," American Economic Review, American Economic Association, vol. 89(1), pages 103-124, March.
  11. Stefano DellaVigna & M. Daniele Paserman, 2004. "Job Search and Impatience," NBER Working Papers 10837, National Bureau of Economic Research, Inc.
  12. David Laibson, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, Oxford University Press, vol. 112(2), pages 443-478.
  13. Steven R. Grenadier & Neng Wang, 2006. "Investment Under Uncertainty and Time-Inconsistent Preferences," NBER Working Papers 12042, National Bureau of Economic Research, Inc.
  14. Drew Fudenberg & David K. Levine, 2006. "A Dual Self Model of Impulse Control," Harvard Institute of Economic Research Working Papers 2112, Harvard - Institute of Economic Research.
  15. E. S. Phelps & R. A. Pollak, 1968. "On Second-Best National Saving and Game-Equilibrium Growth," Review of Economic Studies, Oxford University Press, vol. 35(2), pages 185-199.
  16. W. Pesendorfer & F. Gul, 1999. "Temptation and Self-Control," Princeton Economic Theory Papers 99f1, Economics Department, Princeton University.
  17. Akerlof, George A, 1991. "Procrastination and Obedience," American Economic Review, American Economic Association, vol. 81(2), pages 1-19, May.
  18. Brocas, Isabelle & Carrillo, Juan D, 2001. " Rush and Procrastination under Hyperbolic Discounting and Interdependent Activities," Journal of Risk and Uncertainty, Springer, vol. 22(2), pages 141-64, March.
  19. Brocas, Isabelle & Carrillo, Juan D., 2005. "A theory of haste," Journal of Economic Behavior & Organization, Elsevier, vol. 56(1), pages 1-23, January.
  20. Ted O'Donoghue & Matthew Rabin, 1999. "Incentives for Procrastinators," The Quarterly Journal of Economics, Oxford University Press, vol. 114(3), pages 769-816.
  21. Diamond, Peter & Koszegi, Botond, 2003. "Quasi-hyperbolic discounting and retirement," Journal of Public Economics, Elsevier, vol. 87(9-10), pages 1839-1872, September.
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