OPTIONS, INACTION, AND UNCERTAINTY

Giuseppe Bertola

Scottish Journal of Political Economy, 2010, vol. 57, issue 3, 254-271

Abstract: I outline and discuss economic insights afforded by the elegant and powerful continuous‐time techniques that economists discovered some 20 years ago. I do so in the context of a simple action‐timing problem that does not exploit those techniques, in order to illustrate how the role of uncertainty in shaping the optimality of adoption depends on substantive modeling details. I then outline the clearer implications popular and tractable continuous‐time continuous processes, noting that they may fail to represent key features of some real‐life business investment problems, but provide a suitable toolkit for treatment not only of financial phenomena but also of real option problems, such as those encountered in dynamic consumption problems, where small and unpredictable random changes are realistic.

Date: 2010
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