Real Options with Competition and Incomplete Markets

Alain Bensoussan () and SingRu (Celine) Hoe ()
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Alain Bensoussan: University of Texas at Dallas, International Center for Decision and Risk Analysis, School of Management
SingRu (Celine) Hoe: Texas A&M University-Commerce

A chapter in Inspired by Finance, 2014, pp 29-45 from Springer

Abstract: Abstract Ever since the first attempts to model capital investment decisions as options, financial economists have sought more accurate, more realistic real options models. Strategic interactions and market incompleteness are significant challenges that may render existing classical models inadequate to the task of managing the firm’s capital investments. The purpose of this paper is to address these challenges. The issue of incompleteness comes in for the valuation of payoffs due to absence of a unique martingale measure. One approach is to valuate assets by considering a rational utility-maximizing consumer/investor’s joint decisions with respect to portfolio investment strategy and consumption rule. In our situation, we add the stopping time as an additional decision. We employ variational inequalities (V.I.s) to solve the optimal stopping problems corresponding to times to invest. The regularity of the obstacle (payoffs received at the decision time) is a major element for defining the optimal strategy. Due to the lack of smoothness of the obstacle raised by the game problem, the optimal strategy is a two-interval solution, characterized by three thresholds.

Keywords: Stackelberg leader-follower game; Utility maximization; Bellman equation; Optimal stopping; 91G80; 91A30; 91A15 (search for similar items in EconPapers)
Date: 2014
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Persistent link: https://EconPapers.repec.org/RePEc:spr:sprchp:978-3-319-02069-3_2

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DOI: 10.1007/978-3-319-02069-3_2

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