Optimal investment timing using Markov jump price processes

Fernando A. C. C. Fonte () and Dalila B. M. M. Fontes ()
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Fernando A. C. C. Fonte: Departamento de Matemática para a Ciência e Tecnologia, Universidade do Minho, Portugal
Dalila B. M. M. Fontes: LIAAD and Faculdade de Economia da Universidade do Porto, Portugal

FEP Working Papers from Universidade do Porto, Faculdade de Economia do Porto

Abstract: In this work, we address an investment problem where the investment can either be made immediately or postponed to a later time, in the hope that market conditions become more favourable. In our case, uncertainty is introduced through market price. When the investment is undertaken, a fixed sunk cost must be paid and a series of cash flows are to be received. Therefore, we are faced with an irreversible investment. Real options analysis provides an adequate framework for this type of problems by recognizing these two characteristics, uncertainty and irreversibility, explicitly. We describe algorithmic solutions for this type of problems by modelling market prices evolution by Markov jump processes.

Keywords: Irreversible investment; optimal stopping; dynamic programming; Markov jump processes (search for similar items in EconPapers)
JEL-codes: C61 G31 (search for similar items in EconPapers)
Pages: 25 pages
Date: 2007-07
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