Valuing switching options with the moving-boundary method

Shaunak S. Dabadghao*, Arun Chockalingam, Taimaz Soltani, Jan C. Fransoo

*Corresponding author for this work

Research output: Contribution to journalArticleScientificpeer-review

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Abstract

Switching options can be deployed in various complex switching problems such as tolling agreements and the offshoring-backshoring problem. Closed form solutions to valuing switching options are not only hard, but also computationally intensive when solving numerically. We develop a new computational method to value switching options based on the moving boundary method. We show how the free boundary problem arising from switching options can be converted into a sequence of fixed boundary problems. We formulate the problem, and solve the optimal switching problem in two regimes over a finite time horizon. We establish the theoretical guarantees for this method (maximum principles, uniqueness and convergence). We demonstrate this with a numerical example and show the sensitivity of the solution with regard to the problem parameters.
Original languageEnglish
Article number104124
JournalJournal of Economic Dynamics and Control
Volume127
DOIs
Publication statusPublished - Jun 2021

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