Real Options and American Derivatives: the Double Continuation Region

Anna Battauz, Marzia De Donno and Alessandro Sbuelz

No 499, Working Papers from IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University

Abstract: We thoroughly study the non-standard optimal exercise policy associated with relevant capital investment options and with the prepayment option of widespread collateralized-borrowing contracts like the gold loan. Option exercise is optimally postponed not only when moneyness is insufficient but also when it is excessive. We contribute an important extension of the classical optimal exercise properties for American options. Early exercise of an American call with a negative underlying payout rate can occur if the option is moderately in the money. We fully characterize the existence, the monotonicity, the continuity, the limits and the symptotic behavior at maturity of the double free boundary that separates the exercise region from the double continuation region. We fi?nd that the ?finite-maturity non-standard policy conspicuously differs from the infi?nite-maturity one. Keywords: American Options; Valuation; Optimal Exercise; Real Options; Gold Loan; Collateralized Borrowing; Asymptotic Approximation of The Free Boundary.

Date: 2013
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Journal Article: Real Options and American Derivatives: The Double Continuation Region (2015)
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