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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://128.118.178.162/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://128.118.178.162

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  1. 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.
  2. Ted O'Donoghue & Matthew Rabin, 2001. "Choice And Procrastination," The Quarterly Journal of Economics, MIT Press, vol. 116(1), pages 121-160, February.
  3. Stefano DellaVigna & M. Daniele Paserman, 2004. "Job Search and Impatience," NBER Working Papers 10837, National Bureau of Economic Research, Inc.
  4. Diamond, Peter & Koszegi, Botond, 2003. "Quasi-hyperbolic discounting and retirement," Journal of Public Economics, Elsevier, vol. 87(9-10), pages 1839-1872, September.
  5. Per Krusell & Anthony A Smith, Jr., 2001. "Consumption Savings Decisions with Quasi-Geometric Discounting," NajEcon Working Paper Reviews 625018000000000251, www.najecon.org.
  6. 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.
  7. W. Pesendorfer & F. Gul, 1999. "Self-Control and the Theory of Consumption," Princeton Economic Theory Papers 99f2, Economics Department, Princeton University.
  8. Drew Fudenberg & David K. Levine, 2004. "A Dual Self Model of Impulse Control," Harvard Institute of Economic Research Working Papers 2049, Harvard - Institute of Economic Research.
  9. Ayse Imrohoroglu & Selahattin Imrohoroglu & Douglas H. Joines, 2003. "Time-Inconsistent Preferences And Social Security," The Quarterly Journal of Economics, MIT Press, vol. 118(2), pages 745-784, May.
  10. Akerlof, George A, 1991. "Procrastination and Obedience," American Economic Review, American Economic Association, vol. 81(2), pages 1-19, May.
  11. Susanna Esteban & Eiichi Miyagawa & Matthew Shum, 2003. "Nonlinear Pricing with Self-Control Preferences," Discussion Papers 0304-03, Columbia University, Department of Economics.
  12. Per Krusell & Burhanettin Kuruscu & Anthony A. Smith, Jr., 2000. "Temptation and Taxation," GSIA Working Papers 2001-12, Carnegie Mellon University, Tepper School of Business.
  13. 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.
  14. Krusell, Per & Kuruscu, Burhanettin & Smith, Anthony Jr., 2002. "Time orientation and asset prices," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 107-135, January.
  15. Laibson, David I., 1997. "Golden Eggs and Hyperbolic Discounting," Scholarly Articles 4481499, Harvard University Department of Economics.
  16. Ted O'Donoghue & Matthew Rabin, 1999. "Incentives For Procrastinators," The Quarterly Journal of Economics, MIT Press, vol. 114(3), pages 769-816, August.
  17. W. Pesendorfer & F. Gul, 1999. "Temptation and Self-Control," Princeton Economic Theory Papers 99f1, Economics Department, Princeton University.
  18. Rook, Dennis W, 1987. " The Buying Impulse," Journal of Consumer Research, University of Chicago Press, vol. 14(2), pages 189-99, September.
  19. Brocas, Isabelle & Carrillo, Juan D., 2005. "A theory of haste," Journal of Economic Behavior & Organization, Elsevier, vol. 56(1), pages 1-23, January.
  20. 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.
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