Investment Timing under Incomplete Information

Jean-Paul Décamps, Thomas Mariotti and Stephane Villeneuve

STICERD - Theoretical Economics Paper Series from Suntory and Toyota International Centres for Economics and Related Disciplines, LSE

Abstract: We study the decision of when to invest in an indivisible project whose value is perfectly observable but driven by a parameter that is unknown to the decision maker ex ante. This problem is equivalent to an optimal stopping problem for a bivariate Markov process. Using filtering and martingale techniques, we show that the optimal investment region is characterised by a continuous and non-decreasing boundary in the value/belief state space. This generates path-dependency in the optimal investment strategy. We further show that the decision maker always benefits from an uncertain drift relative to an 'average' drift situation. However, a local study of the investment boundary reveals that the value of the option to invest is not globally increasing with respect to the volatility of the value process.

Keywords: Real options; incomplete information; optimal stopping. (search for similar items in EconPapers)
Date: 2003-01
New Economics Papers: this item is included in nep-fin and nep-rmg
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https://sticerd.lse.ac.uk/dps/te/te444.pdf (application/pdf)

Related works:
Working Paper: Investment Timing under Incomplete Information (2004)
Working Paper: Investment timing under incomplete information (2003)
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Persistent link: https://EconPapers.repec.org/RePEc:cep:stitep:444

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