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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. Ted O'Donoghue & Matthew Rabin, 1997. "Incentives for Procrastinators," Discussion Papers 1181, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  2. Faruk Gul & Wolfgang Pesendorfer, 2004. "Self-Control and the Theory of Consumption," Econometrica, Econometric Society, vol. 72(1), pages 119-158, 01.
  3. 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.
  4. Rook, Dennis W, 1987. " The Buying Impulse," Journal of Consumer Research, University of Chicago Press, vol. 14(2), pages 189-99, September.
  5. 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.
  6. Akerlof, George A, 1991. "Procrastination and Obedience," American Economic Review, American Economic Association, vol. 81(2), pages 1-19, May.
  7. Ayse Imrohoroglu & Selahattin Imrohoroglu & Douglas H. Joines, 2000. "Time inconsistent preferences and Social Security," Discussion Paper / Institute for Empirical Macroeconomics 136, Federal Reserve Bank of Minneapolis.
  8. Laibson, David I., 1997. "Golden Eggs and Hyperbolic Discounting," Scholarly Articles 4481499, Harvard University Department of Economics.
  9. Grenadier, Steven R. & Wang, Neng, 2007. "Investment under uncertainty and time-inconsistent preferences," Journal of Financial Economics, Elsevier, vol. 84(1), pages 2-39, April.
  10. Krusell, Per & Kuruscu, Burhanettin & Smith, Anthony Jr., 2002. "Time orientation and asset prices," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 107-135, January.
  11. Per Krusell & Anthony A. Smith, Jr., 2003. "Consumption--Savings Decisions with Quasi--Geometric Discounting," Econometrica, Econometric Society, vol. 71(1), pages 365-375, January.
  12. 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.
  13. Per Krusell & Burhanettin Kuruşçu & Anthony A. Smith Jr., 2010. "Temptation and Taxation," Econometrica, Econometric Society, vol. 78(6), pages 2063-2084, November.
  14. Faruk Gul & Wolfgang Pesendorfer, 2001. "Temptation and Self-Control," Econometrica, Econometric Society, vol. 69(6), pages 1403-1435, November.
  15. 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.
  16. 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.
  17. 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.
  18. Stefano DellaVigna & M. Daniele Paserman, 2004. "Job Search and Impatience," NBER Working Papers 10837, National Bureau of Economic Research, Inc.
  19. Diamond, Peter & Koszegi, Botond, 2003. "Quasi-hyperbolic discounting and retirement," Journal of Public Economics, Elsevier, vol. 87(9-10), pages 1839-1872, September.
  20. Brocas, Isabelle & Carrillo, Juan D., 2005. "A theory of haste," Journal of Economic Behavior & Organization, Elsevier, vol. 56(1), pages 1-23, January.
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