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Optimal investment timing using Markov jump price processes

Author

Listed:
  • Fernando A. C. C. Fonte

    () (Departamento de Matemática para a Ciência e Tecnologia, Universidade do Minho, Portugal)

  • Dalila B. M. M. Fontes

    () (LIAAD and Faculdade de Economia da Universidade do Porto, Portugal)

Abstract

In this work, we address an investment problem where the investment can either be made immediately or postponed to a later time, in the hope that market conditions become more favourable. In our case, uncertainty is introduced through market price. When the investment is undertaken, a fixed sunk cost must be paid and a series of cash flows are to be received. Therefore, we are faced with an irreversible investment. Real options analysis provides an adequate framework for this type of problems by recognizing these two characteristics, uncertainty and irreversibility, explicitly. We describe algorithmic solutions for this type of problems by modelling market prices evolution by Markov jump processes.

Suggested Citation

  • Fernando A. C. C. Fonte & Dalila B. M. M. Fontes, 2007. "Optimal investment timing using Markov jump price processes," FEP Working Papers 245, Universidade do Porto, Faculdade de Economia do Porto.
  • Handle: RePEc:por:fepwps:245
    as

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    File URL: http://www.fep.up.pt/investigacao/workingpapers/07.07.30_wp245_FontesFontes.pdf
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    References listed on IDEAS

    as
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    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Irreversible investment; optimal stopping; dynamic programming; Markov jump processes;

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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