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The real option with an absorbing barrier

Author

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  • Minh Ha-Duong

    (EPP - Department of Engineering and Public Policy, Carnegie Mellon University - CMU - Carnegie Mellon University [Pittsburgh], CIRED - centre international de recherche sur l'environnement et le développement - Cirad - Centre de Coopération Internationale en Recherche Agronomique pour le Développement - EHESS - École des hautes études en sciences sociales - AgroParisTech - ENPC - École nationale des ponts et chaussées - CNRS - Centre National de la Recherche Scientifique)

  • Benoit Morel

    (EPP - Department of Engineering and Public Policy, Carnegie Mellon University - CMU - Carnegie Mellon University [Pittsburgh])

Abstract

This paper analyzes the theoretical problem of the real option with barrier. It models an investment decision with a double irreversibility concern: investing is irreversible, but waiting runs the risk of loosing the opportunity to invest. The optimal strategy leads to earlier investment when the barrier increases, or when uncertainty decreases. Uncertainty has ambiguous effects on the expected decision time and on the investment probability after N years. Analytical and numerical results also apply to the perpetual American call with a down-and-out barrier on a dividend paying asset.

Suggested Citation

  • Minh Ha-Duong & Benoit Morel, 2003. "The real option with an absorbing barrier," Post-Print halshs-00003976, HAL.
    • Handle: RePEc:hal:journl:halshs-00003976
    Note: View the original document on HAL open archive server: https://shs.hal.science/halshs-00003976v1
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    File URL: https://shs.hal.science/halshs-00003976v1/document
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    References listed on IDEAS

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    1. Ha-Duong, Minh, 1998. "Quasi-option value and climate policy choices," Energy Economics, Elsevier, vol. 20(5-6), pages 599-620, December.
    2. Gao, Bin & Huang, Jing-zhi & Subrahmanyam, Marti, 2000. "The valuation of American barrier options using the decomposition technique," Journal of Economic Dynamics and Control, Elsevier, vol. 24(11-12), pages 1783-1827, October.
    3. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    4. William A. Brock & Michael Rothschild & Joseph E. Stiglitz, 1989. "Stochastic Capital Theory," Palgrave Macmillan Books, in: George R. Feiwel (ed.), Joan Robinson and Modern Economic Theory, chapter 20, pages 591-622, Palgrave Macmillan.
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    Cited by:

    1. Paul Magis & Alessandro Sbuelz, 2006. "The Value Of Fighting Irreversible Demise By Softening The Irreversible Cost," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 9(04), pages 503-516.
    2. Magis, P. & Sbuelz, A., 2005. "The Value of Fighting Irreversible Demise by Softening the Irreversible Cost," Other publications TiSEM d1ee4831-05b4-4d1f-a02e-6, Tilburg University, School of Economics and Management.
    3. Magis, P. & Sbuelz, A., 2005. "The Value of Fighting Irreversible Demise by Softening the Irreversible Cost," Discussion Paper 2005-26, Tilburg University, Center for Economic Research.

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