Investment decisions with two-factor uncertainty

Tine Compernolle, Kuno J. M. Huisman, Peter M. Kort, Maria Lavrutich*, Claudia Nunes, Jacco J. J. Thijssen

*Corresponding author for this work

Research output: Contribution to journalArticleScientificpeer-review

Abstract

This paper considers investment problems in real options with non-homogeneous two-factor uncertainty. We derive some analytical properties of the resulting optimal stopping problem and present a finite difference algorithm to approximate the firm's value function and optimal exercise boundary. An important message in our paper is that the frequently applied quasi-analytical approach underestimates the impact of uncertainty. This is caused by the fact that the quasi-analytical solution does not satisfy the partial differential equation that governs the value function. As a result, the quasi-analytical approach may wrongly advise to invest in a substantial part of the state space.
Original languageEnglish
Article number534
Number of pages17
JournalJournal of Risk and Financial Management
Volume14
Issue number11
DOIs
Publication statusPublished - Nov 2021

Keywords

  • investment analysis
  • optimal stopping time problem
  • two-factor uncertainty
  • REAL OPTIONS
  • AMERICAN
  • PROJECTS
  • OIL

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