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Option Exercise with Temptation

  • Jianjun 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 gratification and suffers 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 firm may exit even if it makes positive net profits; and (iii) if both rewards and costs are immediate, an agent may simply follow the myopic rule which compares only the current period benefit and cost.

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File URL: http://econwpa.repec.org/eps/mic/papers/0409/0409002.pdf
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Paper provided by EconWPA in its series Microeconomics with number 0409002.

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Length: 30 pages
Date of creation: 11 Sep 2004
Date of revision:
Handle: RePEc:wpa:wuwpmi:0409002
Note: Type of Document - pdf; pages: 30
Contact details of provider: Web page: http://econwpa.repec.org

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  1. 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.
  2. Stefano DellaVigna & M. Daniele Paserman, 2005. "Job Search and Impatience," Journal of Labor Economics, University of Chicago Press, vol. 23(3), pages 527-588, July.
  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. Rook, Dennis W, 1987. " The Buying Impulse," Journal of Consumer Research, Oxford University Press, vol. 14(2), pages 189-99, September.
  5. Faruk Gul & Wolfgang Pesendorfer, 2001. "Temptation and Self-Control," Econometrica, Econometric Society, vol. 69(6), pages 1403-1435, November.
  6. Ted O' Donoghue and Matthew Rabin., 2000. "Choice and Procrastination," Economics Working Papers E00-281, University of California at Berkeley.
  7. Per Krusell & Burhanettin Kuruscu & Anthony A. Smith, Jr., 2000. "Temptation and Taxation," GSIA Working Papers 2001-12, Carnegie Mellon University, Tepper School of Business.
  8. Ted O'Donoghue & Matthew Rabin, 1997. "Incentives for Procrastinators," Discussion Papers 1181, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  9. 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.
  10. 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.
  11. 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.
  12. Brocas, Isabelle & Carrillo, Juan D., 2005. "A theory of haste," Journal of Economic Behavior & Organization, Elsevier, vol. 56(1), pages 1-23, January.
  13. David Laibson, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, Oxford University Press, vol. 112(2), pages 443-478.
  14. Faruk Gul & Wolfgang Pesendorfer, 2004. "Self-Control and the Theory of Consumption," Econometrica, Econometric Society, vol. 72(1), pages 119-158, 01.
  15. 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.
  16. Drew Fudenberg & David K Levine, 2005. "A Dual Self Model of Impulse Control," Levine's Working Paper Archive 618897000000000876, David K. Levine.
  17. Akerlof, George A, 1991. "Procrastination and Obedience," American Economic Review, American Economic Association, vol. 81(2), pages 1-19, May.
  18. 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.
  19. 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.
  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. Diamond, Peter & Koszegi, Botond, 2003. "Quasi-hyperbolic discounting and retirement," Journal of Public Economics, Elsevier, vol. 87(9-10), pages 1839-1872, September.
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