Investment timing under incomplete information

Jean-Paul Décamps, Thomas Mariotti and Stephane Villeneuve

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We study the decision of when to invest in an indivisible project whose value is perfectly observable but driven by a parameter that is unknown to the decision maker ex ante. This problem is equivalent to an optimal stopping problem for a bivariate Markov process. Using filtering and martingale techniques, we show that the optimal investment region is characterised by a continuous and non-decreasing boundary in the value/belief state space. This generates path-dependency in the optimal investment strategy. We further show that the decision maker always benefits from an uncertain drift relative to an 'average' drift situation. However, a local study of the investment boundary reveals that the value of the option to invest is not globally increasing with respect to the volatility of the value process.

Keywords: Real options; incomplete information; optimal stopping (search for similar items in EconPapers)
JEL-codes: C61 D83 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2003-01
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http://eprints.lse.ac.uk/19325/ Open access version. (application/pdf)

Related works:
Working Paper: Investment Timing under Incomplete Information (2004)
Working Paper: Investment Timing under Incomplete Information (2003)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:19325

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