Real options and the universal bad news principle
A general framework for pricing of real options in continuous time for wide classes of payoff streams that are monotone functions of a Levy process is provided. Exercise rules are formulated in terms of statistics of record-setting low payoffs and can be viewed as an extension of Bernanke's bad news principle. To illustrate the framework, we solve analytically the following problems: a capital expansion program when the underlying price exhibits mean reverting features; an entry decision with an option to exit, and a new technology adoption. The effects of industry specific and idiosyncratic risks are separated. The third model is driven by two factors: one describes the dynamics of the frontier technology, the other incorporates non-technological uncertainty. The former factor follows a process with upward jumps. The impact of these factors on new technology adoption is analyzed.
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Abel, Andrew B. & Eberly, Janice C., 1999.
"The effects of irreversibility and uncertainty on capital accumulation,"
Journal of Monetary Economics,
Elsevier, vol. 44(3), pages 339-377, December.
- Andrew B. Abel & Janice B. Eberly, "undated". "The Effects of Irreversibility and Uncertainty on Capital Accumulation," Rodney L. White Center for Financial Research Working Papers 21-95, Wharton School Rodney L. White Center for Financial Research.
- Andrew B. Abel & Janice C. Eberly, 1995. "The Effects of Irreversibility and Uncertainty on Capital Accumulation," NBER Working Papers 5363, National Bureau of Economic Research, Inc.
- Svetlana Boyarchenko, 2004. "Irreversible Decisions and Record-Setting News Principles," American Economic Review, American Economic Association, vol. 94(3), pages 557-568, June.
- Angus Deaton & Guy Laroque, 1992. "On the Behaviour of Commodity Prices," Review of Economic Studies, Oxford University Press, vol. 59(1), pages 1-23.
- Deaton, A. & Laroque, G., 1989. "On The Behavior Of Commodity Prices," Papers 145, Princeton, Woodrow Wilson School - Development Studies.
- Angus Deaton & Guy Laroque, 1990. "On The Behavior of Commodity Prices," NBER Working Papers 3439, National Bureau of Economic Research, Inc.
- Deaton, A. & Laroque, G., 1989. "On The Behavior Of Commodity Prices," Papers 145, Princeton, Woodrow Wilson School - Public and International Affairs.
- Schwartz, Eduardo S, 1997. " The Stochastic Behavior of Commodity Prices: Implications for Valuation and Hedging," Journal of Finance, American Finance Association, vol. 52(3), pages 923-973, July.
- Svetlana Boyarchenko & Sergei Levendorskii, 2004. "Universal bad news principle and pricing of options on dividend-paying assets," Papers cond-mat/0404108, arXiv.org.
- Lander, Diane M. & Pinches, George E., 1998. "Challenges to the Practical Implementation of Modeling and Valuing Real Options," The Quarterly Review of Economics and Finance, Elsevier, vol. 38(3, Part 2), pages 537-567.
- Seung-Ryong Yang & B. Wade Brorsen, 1992. "Nonlinear Dynamics of Daily Cash Prices," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 74(3), pages 706-715. Full references (including those not matched with items on IDEAS)