Real Options and American Derivatives: The Double Continuation Region

Anna Battauz (), Marzia De Donno and Alessandro Sbuelz ()
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Anna Battauz: Department of Finance and Innocenzo Gasparini Institute for Economic Research, Bocconi University, 20136 Milan, Italy
Alessandro Sbuelz: Department of Econometrics and Mathematics for Economic, Financial and Actuarial Applications, Catholic University of Milan, 20123 Milan, Italy

Management Science, 2015, vol. 61, issue 5, 1094-1107

Abstract: We study the nonstandard optimal exercise policy associated with relevant capital investment options and with the prepayment option of widespread collateralized-borrowing contracts like the gold loan. Option exercise is optimally postponed not only when moneyness is insufficient, but also when it is excessive. We extend the classical optimal exercise properties for American options. Early exercise of an American call with a negative underlying payout rate can occur if the option is moderately in the money. We fully characterize the existence, the monotonicity, the continuity, the limits, and the asymptotic behavior at maturity of the double free boundary that separates the exercise region from the double continuation region. We find that the finite-maturity nonstandard policy conspicuously differs from the infinite-maturity one. This paper was accepted by Jerome Detemple, finance.

Keywords: American options; valuation; optimal exercise; real options; gold loan; collateralized borrowing; asymptotic approximation of the free boundary; put--call symmetry (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (13)

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Working Paper: Real Options and American Derivatives: the Double Continuation Region (2013)
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