Model-free analysis of real option exercise probability and timing

Sang Baum Kang and Pascal Létourneau

Quantitative Finance, 2023, vol. 23, issue 10, 1531-1544

Abstract: This paper investigates the effects of modifying a real option's characteristics on its holding value and optimal exercise decision using quantile-preserving spreads and stochastic dominance. We show that the change in exercise probability and timing depends on the preserved quantile, strike price, time of modification, and modification symmetry, and we significantly generalize previously obtained results to an unspecified underlying process and a general call-like payoff function. Our results offer testable predictions that contribute to the literature on climate finance, real options, and financial options and provide practical guidance for determining how to modify a real option to increase or decrease its exercise probability and timing.

Date: 2023
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DOI: 10.1080/14697688.2023.2243995

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