Optimal Investment under Cost Uncertainty

Jerome Detemple and Yerkin Kitapbayev
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Yerkin Kitapbayev: Questrom School of Business, Boston University, Boston, MA 02215, USA

Risks, 2018, vol. 6, issue 1, 1-19

Abstract: This paper studies the valuation of real options when the cost of investment jumps at a random time. Three valuation formulas are derived. The first expresses the value of the project in terms of a collection of knockout barrier claims. The second identifies the premium relative to a project with delayed investment right and prices its components. The last one identifies the premium/discount relative to a project with constant cost equal to the post-jump cost and prices its components. All formulas are in closed form. The behavior of optimal investment boundaries and valuation components are examined.

Keywords: American option; real options; optimal stopping; random strike; early exercise premium; free-boundary problem (search for similar items in EconPapers)
JEL-codes: C G0 G1 G2 G3 K2 M2 M4 (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:gam:jrisks:v:6:y:2018:i:1:p:5-:d:128119

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