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Option Exercise with Temptation

Author

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  • Jianjun Miao

    (Department of Economics, Boston University)

Abstract

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.

Suggested Citation

  • Jianjun Miao, 2004. "Option Exercise with Temptation," Microeconomics 0409002, EconWPA.
  • Handle: RePEc:wpa:wuwpmi:0409002
    Note: Type of Document - pdf; pages: 30
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    File URL: https://econwpa.ub.uni-muenchen.de/econ-wp/mic/papers/0409/0409002.pdf
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    References listed on IDEAS

    as
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    Citations

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    Cited by:

    1. David K. Levine & Drew Fudenberg, 2006. "A Dual-Self Model of Impulse Control," American Economic Review, American Economic Association, vol. 96(5), pages 1449-1476, December.
    2. repec:zur:iewwpx:488 is not listed on IDEAS
    3. David Laibson, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, Oxford University Press, vol. 112(2), pages 443-478.
    4. Tsvetan Tsvetanov & Kathleen Segerson, 2011. "Re-Evaluating the Role of Energy Efficiency Standards: A Time-Consistent Behavioral Economics Approach," Working papers 2011-24, University of Connecticut, Department of Economics.
    5. Klaus Nehring, 2006. "Self-Control through Second-Order Preferences," Levine's Bibliography 321307000000000391, UCLA Department of Economics.
    6. Isao Shoji & Sumei Kanehiro, 2012. "Intertemporal dynamic choice under myopia for reward and different risk tolerances," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 50(1), pages 85-98, May.
    7. Noor, Jawwad, 2007. "Commitment and self-control," Journal of Economic Theory, Elsevier, vol. 135(1), pages 1-34, July.
    8. Tsvetanov, Tsvetan & Segerson, Kathleen, 2013. "Re-evaluating the role of energy efficiency standards: A behavioral economics approach," Journal of Environmental Economics and Management, Elsevier, vol. 66(2), pages 347-363.
    9. D.Dragone, 2005. "Incoerenza Dinamica ed Autocontrollo: Proposta per un'Analisi Interdisciplinare," Working Papers 549, Dipartimento Scienze Economiche, Universita' di Bologna.
    10. Hsiaw, Alice, 2013. "Goal-setting and self-control," Journal of Economic Theory, Elsevier, vol. 148(2), pages 601-626.
    11. Kyle Hyndman & Alberto Bisin, 2009. "Procrastination, Self-Imposed Deadlines and Other Commitment Devices," Departmental Working Papers 0904, Southern Methodist University, Department of Economics.
    12. repec:eee:gamebe:v:107:y:2018:i:c:p:329-344 is not listed on IDEAS
    13. Zou, Ziran & Chen, Shou & Wedge, Lei, 2014. "Finite horizon consumption and portfolio decisions with stochastic hyperbolic discounting," Journal of Mathematical Economics, Elsevier, vol. 52(C), pages 70-80.
    14. Sebastian Vollmer & Juditha Wójcik, 2017. "The long-term consequences of the global 1918 influenza pandemic: A systematic analysis of 117 IPUMS international census data sets," Working Papers 1721, Gutenberg School of Management and Economics, Johannes Gutenberg-Universität Mainz.
    15. Houser, Daniel & Schunk, Daniel & Winter, Joachim & Xiao, Erte, 2018. "Temptation and commitment in the laboratory," Games and Economic Behavior, Elsevier, vol. 107(C), pages 329-344.
    16. Tsvetan Tsvetanov & Kathleen Segerson, 2014. "The Welfare Effects of Energy Efficiency Standards When Choice Sets Matter," Journal of the Association of Environmental and Resource Economists, University of Chicago Press, vol. 1(1), pages 233-271.
    17. repec:spr:joptap:v:146:y:2010:i:3:d:10.1007_s10957-010-9687-0 is not listed on IDEAS

    More about this item

    Keywords

    self-control; temptation; procrastination; preproperation; option value;

    JEL classification:

    • D1 - Microeconomics - - Household Behavior
    • D2 - Microeconomics - - Production and Organizations
    • D3 - Microeconomics - - Distribution
    • D4 - Microeconomics - - Market Structure, Pricing, and Design

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