REAL OPTIONS WITH PRICED REGIME-SWITCHING RISK

Edward Driffill (), Turalay Kenc () and Martin Sola
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Turalay Kenc: Central Bank of Turkey, Istiklal Caddesi 10, Ulus. 06100 Ankara, Turkey

International Journal of Theoretical and Applied Finance (IJTAF), 2013, vol. 16, issue 05, 1-30

Abstract: We develop a model of regime-switching risk premia as well as regime-dependent factor risk premia to price real options. The model incorporates the observation that the underlying risky income streams of real options are subject to discrete shifts over time as well as random changes. The presence of discrete shifts is due to systematic and unsystematic risk associated with changes in business cycles or in economic policy regimes or events such as takeovers, major changes in business plans. We analyze the impact of regime-switching behavior on the valuation of projects and investment opportunities. We find that accounting for Markov switching risk results in a delay in the expected timing of the investment while the regime-specific factor risk premia make the possibility of a regime shift more pronounced.

Keywords: Regime-switching risk premia; regime-dependent risk premia; real options (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (4)

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Working Paper: Real Options with Priced Regime-Switching Risk (2009)
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DOI: 10.1142/S0219024913500283

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