Narrow Results

Under uncertainty of exchange rate, we extend the batch process production model of Lin et al. (2002) by considering an export-oriented manufacturer making decisions to switch freely between domestic and foreign locations. The export-oriented manufacturer is risk neutral and has rational expectations. We use dynamic programming and Lagrange multiplies for a stochastic optimization control problem to get the productive value of exporter produces in domestic and foreign locations. Next, the export-oriented manufacturer can make decision regarding the optimal entry (exit) trigger for transferable locations wherever the product locations are. It provides the supplier with another way to make decisions.

This study considers the effects of two real exchange rates on strategies that govern the locations of production by firms that are entering two foreign countries. The batch process production model of Lin and Wu (Asia-Pacific Journal of Operational Research, 21, 2004, 35–52), which considers two locations of production, one in each of two countries is extended to develop a decision valuation model to choose the two optimal locations to produce a good — one in each country. This extended model applies the Real Options Analysis (ROA) to determine the value of locating production in three countries. Moreover, a closed-form solution to the Continuous-Time Model Optimization Problem is derived. The optimal entry trigger and expected arrival time of an exporter from country-0 to country-1 or 2 are calculated; a sensitivity analysis is performed, and some characteristic strategies of the operating method for the Cobb–Douglas batch process model among three countries are determined. A useful summary of insights is provided for global managers.

This study applies the real options approach to examine the maximum net present value of the market entry/exit thresholds given uncertain cash flows. The discount and growth factors are determined in the proposed entry/exit models, facilitating the complex calculation of the discount and growth rates to determine the present value of cash flow streams. Accordingly, this work successfully combines the maximum net present value method and the real options approach for decision-making by simply considering the discount and growth factors.

This study considers the effects of one real exchange rate on strategies that govern locations of production by firms that are entering N - 1 foreign countries. The batch process production model (Lin, CT and CR Wu (2004a). Asia Pacific Journal of Operational Research, 21, 35–52) which considers two locations of production, one in each of two countries is extended to develop a decision valuation model to choose the two optimal locations to produce a good — one in each country. This extended model applies the real options approach (ROA) to determine the value of locating production in N countries. Moreover, a closed-form solution to the Continuous-Time Model Optimization Problem is derived. The optimal entry threshold value of a firm from country-0 to country-(N - 1) is calculated; a sensitivity analysis is performed, and some characteristic strategies of the operating method for the Constant Elasticity of Substitution (CES) batch process model among N countries are determined. Next, we can get optimal entry threshold value for Cobb-Douglas, perfect substitution and Leontief by CES production function. A useful summary of insights is provided for global managers.

The paper mainly aims to introduce the real options approach to construct an evaluation model for the firm value under partial financing funds. The paper examines that production volume follows the geometric Brownian motion and considers that both the market entry of investment cost and the market exit of withdrawal cost match the linear function with production volume. Then the paper evaluates the potential firm value before market entry, the operational value with the firm's operating, and the market exit value with the firm's stopping to operate so as to assess the whole firm value, shareholder value, and bondholder value hereafter. The results show that different debt ratios will affect the firm's investment decision. The paper figures out the optimal decision-making based on the maximum profit of shareholders or the maximum profit of shareholders-and-bondholders. The factor is finance leverage; although interest expenses are tax deductible, an overly high leverage may trigger agency costs for a firm, which will offset the tax shields associated with leverage. Therefore, a firm should not leverage too much. Furthermore, the paper constructs an innovative evaluation model in a dynamic-financing environment in order to provide the management team with a decision-making mechanism for their decisions in market entry or market exit in a timely manner in the face of uncontrollable exogenous variables.

We consider an optimal investment problem when a firm such as an electric power company has the operational flexibility to expand and contract capacity with fixed cost. This problem is formulated as an impulse control problem combined with optimal stopping. Consequently, we obtain optimal investment timing, optimal capacity expansion and contraction timing, and the investment value. We also show investment, capacity expansion and contraction rule are influenced by the price volatility and the initial capacity is also influenced by the ratio between base-load plant and peak-load plant. In addition, we investigate how time lag between investment and operation influences the investment rule.

In this paper, we develop a real options framework that sets rules for investment decision in sustainable transport projects under both demand and costs uncertainties. First, we present the model we use to calculate the cost of transport externalities. Using stochastic analysis, we show how to maximize inter-generational utility by choosing the optimal time to invest. The method is implemented using a dynamic programming approach that gives, at each moment, the thresholds for demand and cost for which it is optimal to invest. We calculate the expected waiting time until investing and perform a sensitivity analysis to study the impact of the different parameters on the decision.

This paper analyzes irreversible investments in technology under asymmetric duopoly. Asset prices are defined by a diffusion with Poisson jumps. Assuming negative externalityfor profit flows, we develop a real options and game theoretic valuation model to evaluate the optimal investment strategies under interaction. Three types of equilibrium, i.e., simultaneous equilibrium, preemptive equilibrium, and sequential equilibrium, are attainable depending on the firms’ competitive advantageand first-mover advantage. The role of a firm, as “leader”, “follower”, or “simultaneous entrant”, is analyzed both exogenously and endogenously. We find that preemptive competition lowers both firms’ profits from the investments in the technology. Numerical examples illustrate the key results.

We consider an option c which is contingent on an underlying that is not a traded asset. This situation typically arises in the context of real options. We investigate the situation when there is a "surrogate" traded asset S whose price process is highly correlated with that of . An illustration would be the cases where S and model two different brands of crude oil. The main result of the paper shows that in this case one cannot draw any non-trivial conclusions on the price of the option by only using no-arbitrage arguments.

In a second step we try to isolate hedging strategies on the traded asset S which minimize the variance of the hedging error. We show in particular, that the naive strategy of simply replacing by S fails to be optimal and we are able to quantify how far it is from being optimal.

A canonical problem in real option pricing, as described in the classic text of Dixit and Pindyck [2], is to determine the optimal time to invest at a fixed cost, to receive in return a stochastic cashflow. In this paper we are interested in this problem in an incomplete market where the cashflow is not spanned by the traded assets. We follow the formulation in Miao and Wang [21]; our contribution is to show that significant progress can be made in solving the Hamilton-Jacobi-Bellman equation and that the optimal exercise threshold can be characterized quite precisely.

We address the issue of finding a strategy to sustain structural profitability of an investment project, whose production activity depends on the market price of a number of underlying commodities. Depending on the fluctuating prices of these commodities, the activity will either continue until the project's profitability reaches a critical low level at which it is stopped and starts again when it becomes profitable. But, if the structural nonprofitability remains for a while, the investment project will face the risk to be abandoned or be definitely closed. We suggest a general probabilistic set up to model profitability as a function of the market price of a set of commodities, and find the related optimal strategy to sustain it, under the constraint that the project faces the abandonment risk when being nonprofitable under a fixed finite time interval. When the market price dynamics is described by a diffusion process, we show that the optimal strategy is related to viscosity solutions of a system of two variational inequalities with inter-connected obstacles.

Public owners face a constant demand for developing new projects and for funding the renewal, maintenance and operation of existing infrastructure projects. One way to raise capitals to provide new financial resources to constrained budgets is to securitize a stream of revenue cash flows from a portfolio of mature infrastructure projects. We present a new type of PBS, the revenue performance-linked project backed securities (PBS), with embedded call and put options. In this new PBS setting, risks for issuers and buyers can be confined within a cut-off area. This risk hedging feature is expected to facilitate the trading of such products.

We consider the strategic interaction between two firms competing for the opportunity to invest in a project with uncertain future values. Starting in complete markets, we provide a rigorous characterization of the strategies followed by each firm in continuous time in the context of a timing/coordination game. In particular, the roles of leader and follower emerge from the resulting symmetric, Markov, sub-game perfect equilibrium. Comparing the expected value obtained by each firm in this case with that obtained when the roles of leader and follower are predetermined, we are able to calculate the amount of money that a firm would be willing to spend in advance (either by paying a license or acquiring market power) to have the right to be the leader in a subsequent game — what we call the priority option. We extend these results to incomplete markets by using utility-indifference arguments.

We develop a model of regime-switching risk premia as well as regime-dependent factor risk premia to price real options. The model incorporates the observation that the underlying risky income streams of real options are subject to discrete shifts over time as well as random changes. The presence of discrete shifts is due to systematic and unsystematic risk associated with changes in business cycles or in economic policy regimes or events such as takeovers, major changes in business plans. We analyze the impact of regime-switching behavior on the valuation of projects and investment opportunities. We find that accounting for Markov switching risk results in a delay in the expected timing of the investment while the regime-specific factor risk premia make the possibility of a regime shift more pronounced.

In this paper, we study the financing of high uncertainty projects. High uncertainty is defined as the lack of knowledge of whether growth options exist. In this paper, we will describe this uncertainty by a probability distribution which describes the arrival of a growth option at a deterministic time. Once the option arrives, an additional uncertainty exists since it is not certain that it is profitable to exercise it. We value the corporate securities with contingent claims valuation both for a whole equity-financed firm and a debt-equity-financed firm. Unlike traditional capital structure models, we find nonconvex value functions for the firm vis-a-vis the debt coupon under specific parametrizations. High and low leverage can yield similar firm value maximizing policies.

Real option valuation has traditionally been concerned with investment under project value uncertainty while assuming that the agent has perfect confidence in a specific model. However, agents do not generally have perfect confidence in their model and this ambiguity may affect their decisions. In addition, the value of real investments is not typically fully spanned by tradable assets because markets are incomplete as is typically the case in energy and commodities. In this paper, we account for the agent’s aversion to model ambiguity and address market incompleteness through the notion of robust indifference prices. We derive analytical results for the perpetual option to invest and the linear complementarity problem that the finite-time version of this problem satisfies. Ambiguity aversion has a number of effects on decision making some of which cannot be explained by altering the agent’s risk aversion. For example, ambiguity averse agents are found to exercise real options both earlier and later than their ambiguity neutral counterparts, depending on whether ambiguity stems from uncertainty in the dynamics of the project value or the dynamics of a hedging asset.

We study a mean-field game framework in which agents expend costly effort in order to transition into a state where they receive cash flows. As more agents transition into the cash flow receiving state, the magnitude of all remaining cash flows decreases, introducing an element of competition whereby agents are rewarded for transitioning earlier. An equilibrium is reached if the optimal expenditure of effort produces a transition intensity which is equal to the flow rate at which the continuous population enters the receiving state. We give closed-form expressions which yield equilibrium when the cash flow horizon is infinite or exponentially distributed. When the cash flow horizon is finite, we implement an algorithm which yields equilibrium if it converges. We show that in some cases, a higher cost of effort results in the agents placing greater value on the potential cash flows in equilibrium. We also present cases where the algorithm fails to converge to an equilibrium.

We analyze the real option signaling game models of debt financing of a risky project under information asymmetry, where the firm quality is only known to the firm management but not outsiders. The firm decides on the optimal investment timing of the risky project that requires upfront fixed funding cost and subsequent operating costs. The fixed funding cost is financed via either direct bank loan or entering into a three-party equity guarantee swap (EGS) that involves a bank granting the loan and third party guarantor. Under the EGS agreement, the guarantor is obligated to pay all the future coupon stream to the bank upon default of the firm. In return for the provision of the guarantee, the guarantor obtains certain proportional share of equity of the firm at the time when the swap agreement is signed. The share of equity demanded by the guarantor depends on the outside investors’ belief on the firm quality. The low-type firm has the incentive to mimic the investment strategy of being high-type in terms of investment timing and share of equity. The high-type firm may adopt the appropriate separating strategy by speeding up investment or choosing an alternative financing choice. The resulting loss of the real option value of the investment opportunity represents the information cost under separating strategies. We examine the incentive compatibility constraints faced by the firm under different quality types and discuss characterization of the separating and pooling equilibriums. Unlike the usual assumption of perpetuity of investment opportunity, our real option model assumes the time window of the investment opportunity to be finite. We explore how the information cost and nature of separating and pooling equilibriums evolves over the finite time span of the investment opportunity. The information costs and investment thresholds exhibit interesting time-dependent behaviors. We examine the firm’s investment and financing choice between EGS and the direct bank loan against time and other parameters via comparison of the corresponding information costs and investment thresholds.

We develop a contingent claim model to examine the interaction between financing and investment where equity holders decide when to default and debt holders decide when to liquidate as well as maximize the liquidation value. We show that if the debt holders maximize the residual value at liquidation, an increase in liquidation value increases the amount of debt issuance and investment quantity ex ante, delaying corporate investment. This relationship is based on the fact that an increase in the liquidation value decreases the credit spread of debt holders. These results fit well with those of existing empirical studies.

This study establishes a dynamic model under real options analysis to analyze the optimal timing decision of information technology (IT) investments when the output price for firms is stochastic and benefits of IT investments are arisen from the increasing output price, increasing sale, and cost savings. We derive the closed form expression of the timing of IT investments and furthermore prove that IT investments rise at an increasing rate in economic booms and fall in economic busts. This study finds that increasing (decreasing) price volatility will delay (advance) the timing of IT investments. Increasing IT investments, however, may not delay the timing of IT investments. In addition, the decreasing (increasing) efficiency and increasing (decreasing) depreciation of IT investments will delay (advance) the timing of IT investments.