Investment Decisions with Two-Factor Uncertainty

Tine Compernolle, Kuno J. M. Huisman, Peter Kort, Maria Lavrutich, Cláudia Nunes and Jacco J. J. Thijssen
Additional contact information
Tine Compernolle: Department of Engineering Management, University of Antwerp, 2000 Antwerp, Belgium
Kuno J. M. Huisman: Department of Econometrics and Operations Research, Tilburg University, 5000 LE Tilburg, The Netherlands
Maria Lavrutich: Department of Industrial Economics and Technology Management, Norwegian University of Science and Technology, 7491 Trondheim, Norway
Cláudia Nunes: Department of Mathematics and CEMAT, Instituto Superior Técnico, 1049-001 Lisbon, Portugal
Jacco J. J. Thijssen: Department of Mathematics, University of York, York YO10 5DD, UK

JRFM, 2021, vol. 14, issue 11, 1-17

Abstract: 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.

Keywords: investment analysis; optimal stopping time problem; two-factor uncertainty (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Related works:
Working Paper: Investment Decisions with Two-Factor Uncertainty (2018)
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