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 language | English |
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Article number | 534 |
Number of pages | 17 |
Journal | Journal of Risk and Financial Management |
Volume | 14 |
Issue number | 11 |
DOIs | |
Publication status | Published - Nov 2021 |
Keywords
- investment analysis
- optimal stopping time problem
- two-factor uncertainty
- REAL OPTIONS
- AMERICAN
- PROJECTS
- OIL