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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
Contact details of provider: Postal: 270 Bay State Road, Boston, MA 02215
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Web page: http://www.bu.edu/econ/

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  1. Akerlof, George A, 1991. "Procrastination and Obedience," American Economic Review, American Economic Association, vol. 81(2), pages 1-19, May.
  2. Laibson, David I., 1997. "Golden Eggs and Hyperbolic Discounting," Scholarly Articles 4481499, Harvard University Department of Economics.
  3. 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.
  4. Drew Fudenberg & David K Levine, 2005. "A Dual Self Model of Impulse Control," Levine's Working Paper Archive 618897000000000876, David K. Levine.
  5. 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.
  6. 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.
  7. Faruk Gul & Wolfgang Pesendorfer, 2001. "Temptation and Self-Control," Econometrica, Econometric Society, vol. 69(6), pages 1403-1435, November.
  8. Ted O'Donoghue & Matthew Rabin, 1996. "Doing It Now or Later," Discussion Papers 1172, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  9. Ayse Imrohoroglu & Selahattin Imrohoroglu & Douglas H. Joines, 2003. "Time-Inconsistent Preferences And Social Security," The Quarterly Journal of Economics, MIT Press, vol. 118(2), pages 745-784, May.
  10. Per Krusell & Anthony A Smith, Jr., 2001. "Consumption Savings Decisions with Quasi-Geometric Discounting," Levine's Working Paper Archive 625018000000000251, David K. Levine.
  11. Grenadier, Steven R. & Wang, Neng, 2005. "Investment under Uncertainty and Time-Inconsistent Preferences," Research Papers 1899, Stanford University, Graduate School of Business.
  12. Ted O' Donoghue and Matthew Rabin., 2000. "Choice and Procrastination," Economics Working Papers E00-281, University of California at Berkeley.
  13. Stefano DellaVigna & M. Daniele Paserman, 2004. "Job Search and Impatience," NBER Working Papers 10837, National Bureau of Economic Research, Inc.
  14. W. Pesendorfer & F. Gul, 1999. "Self-Control and the Theory of Consumption," Princeton Economic Theory Papers 99f2, Economics Department, Princeton University.
  15. Brocas, Isabelle & Carrillo, Juan D., 2005. "A theory of haste," Journal of Economic Behavior & Organization, Elsevier, vol. 56(1), pages 1-23, January.
  16. Per Krusell & Burhanettin Kuruscu & Anthony A. Smith, Jr., 2000. "Temptation and Taxation," GSIA Working Papers 2001-12, Carnegie Mellon University, Tepper School of Business.
  17. Diamond, Peter & Koszegi, Botond, 2003. "Quasi-hyperbolic discounting and retirement," Journal of Public Economics, Elsevier, vol. 87(9-10), pages 1839-1872, September.
  18. Rook, Dennis W, 1987. " The Buying Impulse," Journal of Consumer Research, University of Chicago Press, vol. 14(2), pages 189-99, September.
  19. 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.
  20. Ted O'Donoghue & Matthew Rabin, 1997. "Incentives for Procrastinators," Discussion Papers 1181, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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