Investment Decisions with Two-Factor Uncertainty

This paper considers investment problems in real options with non-homogeneous two-factor uncertainty. We derive some analytical properties of the resulting optimal stopping problem and present a finite difference algorithm to approximate the firm’s value function and optimal exercise boundary. An im...

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Auteurs principaux: Tine Compernolle, Kuno J. M. Huisman, Peter M. Kort, Maria Lavrutich, Cláudia Nunes, Jacco J. J. Thijssen
Format: article
Langue:EN
Publié: MDPI AG 2021
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Accès en ligne:https://doaj.org/article/25ed37a81ea34a8fb0a531267a1a566a
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Résumé:This paper considers investment problems in real options with non-homogeneous two-factor uncertainty. We derive some analytical properties of the resulting optimal stopping problem and present a finite difference algorithm to approximate the firm’s value function and optimal exercise boundary. An important message in our paper is that the frequently applied quasi-analytical approach underestimates the impact of uncertainty. This is caused by the fact that the quasi-analytical solution does not satisfy the partial differential equation that governs the value function. As a result, the quasi-analytical approach may wrongly advise to invest in a substantial part of the state space.