 Learning, pricing, timing and hedging of the option to invest for perpetual cash flows with idiosyncratic riskDandan Song, Huamao Wang and Zhaojun Yang Journal of Mathematical Economics, 2014, vol. 51, issue C, 1-11 Abstract: The paper considers the option of an investor to invest in a project that generates perpetual cash flows, of which the drift parameter is unobservable. The investor invests in a liquid financial market to partially hedge cash flow risk and estimation risk. We derive two 3-dimensional non-linear free-boundary PDEs satisfied by the utility-based prices of the option and cash flows. We provide an approach to measure the information value. A numerical procedure is developed. We show that investors have not only idiosyncratic-risk-induced but also estimation-risk-induced precautionary saving demands. A growth of estimation risk, risk aversion or project risk delays investment, but it is accelerated if the project is more closely correlated with the market. Partial information results in a considerable loss, which reaches the peak value at the exercising time and increases with project risk and estimation risk. The more risk-averse the investor or the weaker the correlation, the larger the loss. Keywords: Partial information; Hedging; Real options; Precautionary savings; Information value; Non-linear PDEs (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:mateco:v:51:y:2014:i:c:p:1-11 DOI: 10.1016/j.jmateco.2014.02.009 Access Statistics for this article Journal of Mathematical Economics is currently edited by Atsushi (A.) Kajii More articles in Journal of Mathematical Economics from Elsevier |
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