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Option Exercise with Temptation

Author

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  • Junjian Miao

    () (Department of Economics, Boston University)

Abstract

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.

Suggested Citation

  • Junjian Miao, 2005. "Option Exercise with Temptation," Boston University - Department of Economics - Working Papers Series WP2005-007, Boston University - Department of Economics.
  • Handle: RePEc:bos:wpaper:wp2005-007
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    References listed on IDEAS

    as
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    Citations

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    Cited by:

    1. Tsvetanov, Tsvetan & Segerson, Kathleen, 2013. "Re-evaluating the role of energy efficiency standards: A behavioral economics approach," Journal of Environmental Economics and Management, Elsevier, vol. 66(2), pages 347-363.
    2. Kyle Hyndman & Alberto Bisin, 2009. "Procrastination, Self-Imposed Deadlines and Other Commitment Devices," Departmental Working Papers 0904, Southern Methodist University, Department of Economics.
    3. repec:zur:iewwpx:488 is not listed on IDEAS
    4. Jawwad Noor, 2005. "Commitment and Self-Control," Boston University - Department of Economics - Working Papers Series WP2005-014, Boston University - Department of Economics.
    5. David K. Levine & Drew Fudenberg, 2006. "A Dual-Self Model of Impulse Control," American Economic Review, American Economic Association, pages 1449-1476.
    6. David K. Levine & Drew Fudenberg, 2006. "A Dual-Self Model of Impulse Control," American Economic Review, American Economic Association, pages 1449-1476.
    7. D.Dragone, 2005. "Incoerenza Dinamica ed Autocontrollo: Proposta per un'Analisi Interdisciplinare," Working Papers 549, Dipartimento Scienze Economiche, Universita' di Bologna.
    8. Tsvetan Tsvetanov & Kathleen Segerson, 2011. "Re-Evaluating the Role of Energy Efficiency Standards: A Time-Consistent Behavioral Economics Approach," Working papers 2011-24, University of Connecticut, Department of Economics.
    9. Tsvetan Tsvetanov & Kathleen Segerson, 2014. "The Welfare Effects of Energy Efficiency Standards When Choice Sets Matter," Journal of the Association of Environmental and Resource Economists, University of Chicago Press, pages 233-271.
    10. Noor, Jawwad, 2007. "Commitment and self-control," Journal of Economic Theory, Elsevier, vol. 135(1), pages 1-34, July.
    11. Klaus Nehring, 2006. "Self-Control through Second-Order Preferences," Levine's Bibliography 321307000000000391, UCLA Department of Economics.
    12. Hsiaw, Alice, 2013. "Goal-setting and self-control," Journal of Economic Theory, Elsevier, vol. 148(2), pages 601-626.
    13. Isao Shoji & Sumei Kanehiro, 2012. "Intertemporal dynamic choice under myopia for reward and different risk tolerances," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), pages 85-98.
    14. David Laibson, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, Oxford University Press, vol. 112(2), pages 443-478.
    15. Zou, Ziran & Chen, Shou & Wedge, Lei, 2014. "Finite horizon consumption and portfolio decisions with stochastic hyperbolic discounting," Journal of Mathematical Economics, Elsevier, vol. 52(C), pages 70-80.

    More about this item

    Keywords

    self-control; temptation; procrastination; preproperation; option value;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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