Real options and the universal bad news principle

Svetlana Boyarchenko () and Sergei Levendorskii
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Sergei Levendorskii: The University of Texas at Austin

Finance from EconWPA

Abstract: A general framework for pricing of real options in continuous time for wide classes of payoff streams that are monotone functions of a Levy process is provided. Exercise rules are formulated in terms of statistics of record-setting low payoffs and can be viewed as an extension of Bernanke's bad news principle. To illustrate the framework, we solve analytically the following problems: a capital expansion program when the underlying price exhibits mean reverting features; an entry decision with an option to exit, and a new technology adoption. The effects of industry specific and idiosyncratic risks are separated. The third model is driven by two factors: one describes the dynamics of the frontier technology, the other incorporates non-technological uncertainty. The former factor follows a process with upward jumps. The impact of these factors on new technology adoption is analyzed.

Keywords: exit and entry; emdebbed options; technology adoption; capital expansion (search for similar items in EconPapers)
JEL-codes: D81 C61 G31 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn and nep-fin
Date: 2004-05-06
Note: Type of Document - pdf; pages: 34
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Working Paper: Real options and the universal bad news principle (2004)
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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpfi:0405011

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