Real Options with Priced Regime-Switching Risk

Edward Driffill (), Martin Sola and Turalay Kenc

Department of Economics Working Papers from Universidad Torcuato Di Tella

Abstract: e develop a model of regime-switching risk premia as well as regimedependent 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 regimeswitching 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.

Keywords: Regime-Switching Risk Premia; Regime-Dependent Risk Premia, Real Options. (search for similar items in EconPapers)
JEL-codes: G12 G31 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2009-09
New Economics Papers: this item is included in nep-cfn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Journal Article: REAL OPTIONS WITH PRICED REGIME-SWITCHING RISK (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:udt:wpecon:2009-09

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