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Competitive investment with varying risk premia

Author

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  • Armerin, Fredrik

    (Department of Real Estate and Construction Management, Royal Institute of Technology)

  • Gunnelin, Åke

    (Department of Real Estate and Construction Management, Royal Institute of Technology)

Abstract

This paper considers a model with a time-varying risk premium. The risk premium is driven by a continuous time Markov chain, representing the state in the economy, and the stochastic process generating the cash flows is a Markov-modulated geometric Brownian motion. An existing firm is facing the possibility of competitors entering the market, and due to this, cash flows are limited at levels which are dependent on the state of the economy. This results in a regulated Markov-modulated geometric Brownian motion, and the resulting accumulated supply can have jumps, something that is not possible in a model with only one regime.

Suggested Citation

  • Armerin, Fredrik & Gunnelin, Åke, 2019. "Competitive investment with varying risk premia," Working Paper Series 19/12, Royal Institute of Technology, Department of Real Estate and Construction Management & Banking and Finance.
    • Handle: RePEc:hhs:kthrec:2019_012
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    References listed on IDEAS

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    3. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-384, March.
    4. Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 101(4), pages 707-727.
    5. John Driffill & Turalay Kenc & Martin Sola, 2013. "Real Options With Priced Regime-Switching Risk," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 16(05), pages 1-30.
    6. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
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    More about this item

    Keywords

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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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