Valuation and Information Acquisition Policy for Claims Written on Noisy Real Assets

Paul Childs, Steven Ott and Timothy Riddiough

Financial Management, 2001, vol. 30, issue 2

Abstract: We study contingent claims written on real assets whose values are observed with noise and the acquisition of information to improve irreversible exercise decisions. We determine the conditional expected asset value and show that it can depend on historical observed values. In a noisy setting, claim values are calculated by simply adjusting the asset value and variance inputs and applying standard valuation procedures for pricing European and American options. Noise tends to slow the rate of information arrival, reduce contingent claim value, and provide incentives to purposefully acquire additional information. These incentives are illustrated for the case of secured risky debt. The value of acquired information increases when the option holder is indifferent between exercise alternatives, and decreases as one choice increasingly dominates the other. Opportunities to repeatedly acquire information reduce over- or underinvestment in information.

Date: 2001
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