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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. O'Donoghue, Ted & Rabin, Matthew, 1997. "Doing It Now or Later," Department of Economics, Working Paper Series qt7t44m5b0, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  2. Ted O'Donoghue & Matthew Rabin, 1999. "Incentives for Procrastinators," The Quarterly Journal of Economics, Oxford University Press, vol. 114(3), pages 769-816.
  3. Krusell, Per & Smith Jr., Anthony A, 2001. "Consumption-Savings Decisions with Quasi-Geometric Discounting," CEPR Discussion Papers 2651, C.E.P.R. Discussion Papers.
  4. Drew Fudenberg & David K Levine, 2005. "A Dual Self Model of Impulse Control," Levine's Working Paper Archive 618897000000000876, David K. Levine.
  5. Per Krusell & Burhanettin Kuruşçu & Anthony A. Smith Jr., 2010. "Temptation and Taxation," Econometrica, Econometric Society, vol. 78(6), pages 2063-2084, November.
  6. Ted O' Donoghue & Matthew Rabin, 2001. "Choice and Procrastination," Microeconomics 0012002, EconWPA.
  7. Brocas, Isabelle & Carrillo, Juan D., 2005. "A theory of haste," Journal of Economic Behavior & Organization, Elsevier, vol. 56(1), pages 1-23, January.
  8. 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.
  9. Faruk Gul & Wolfgang Pesendorfer, 2001. "Temptation and Self-Control," Econometrica, Econometric Society, vol. 69(6), pages 1403-1435, November.
  10. David Laibson, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, Oxford University Press, vol. 112(2), pages 443-478.
  11. Stefano DellaVigna & M. Daniele Paserman, 2004. "Job Search and Impatience," NBER Working Papers 10837, National Bureau of Economic Research, Inc.
  12. 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.
  13. 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.
  14. Esteban, Susanna & Miyagawa, Eiichi & Shum, Matthew, 2007. "Nonlinear pricing with self-control preferences," Journal of Economic Theory, Elsevier, vol. 135(1), pages 306-338, July.
  15. Diamond, Peter & Koszegi, Botond, 2003. "Quasi-hyperbolic discounting and retirement," Journal of Public Economics, Elsevier, vol. 87(9-10), pages 1839-1872, September.
  16. 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.
  17. Faruk Gul & Wolfgang Pesendorfer, 2004. "Self-Control and the Theory of Consumption," Econometrica, Econometric Society, vol. 72(1), pages 119-158, 01.
  18. Akerlof, George A, 1991. "Procrastination and Obedience," American Economic Review, American Economic Association, vol. 81(2), pages 1-19, May.
  19. 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.
  20. 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.
  21. Rook, Dennis W, 1987. " The Buying Impulse," Journal of Consumer Research, Oxford University Press, vol. 14(2), pages 189-99, September.
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