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The Worst Case for Real Options

Author

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  • M. Trojanowska

    (University of Antwerp)

  • P. M. Kort

    (University of Antwerp
    Tilburg University)

Abstract

The problem of the timing of an investment decision under partial information is analyzed in a framework where the firm is ambiguity averse. The analysis yields the description of a robust decision rule for an investment in a finite life project in presence of a stochastic instantaneous return. It is demonstrated that ambiguity aversion may accelerate investment in the short run. Ex post validation of the determined investment policy treats the impact of ambiguity aversion on the proper way of discounting of the profit flow resulting from the project and the fair price of risk associated with ambiguity aversion.

Suggested Citation

  • M. Trojanowska & P. M. Kort, 2010. "The Worst Case for Real Options," Journal of Optimization Theory and Applications, Springer, vol. 146(3), pages 709-734, September.
    • Handle: RePEc:spr:joptap:v:146:y:2010:i:3:d:10.1007_s10957-010-9687-0
    DOI: 10.1007/s10957-010-9687-0
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    Cited by:

    1. Fouilloux, Jessica & Moraux, Franck & Viviani, Jean-Laurent, 2015. "Investing in finite-life carbon emissions reduction program under risk and idiosyncratic uncertainty," Energy Policy, Elsevier, vol. 82(C), pages 310-320.
    2. Álvaro Cartea & Sebastian Jaimungal, 2017. "Irreversible Investments And Ambiguity Aversion," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 20(07), pages 1-26, November.
    3. So, Leh-chyan, 2013. "Are Real Options “Real”? Isolating Uncertainty from Risk in Real Options Analysis," MPRA Paper 52493, University Library of Munich, Germany.
    4. Cho, In-Koo & Kasa, Kenneth, 2014. "An escape time interpretation of robust control," Journal of Economic Dynamics and Control, Elsevier, vol. 42(C), pages 1-12.
    5. Gao, Yongling & Driouchi, Tarik & Bennett, David J., 2018. "Ambiguity aversion in buyer-seller relationships: A contingent-claims and social network explanation," International Journal of Production Economics, Elsevier, vol. 200(C), pages 50-67.
    6. David Roubaud, 2022. "A real option to divest with two correlated sources of ambiguity," Economics Bulletin, AccessEcon, vol. 42(2), pages 591-602.
    7. Zhao, Zhiming & Liu, Yuyao & Pan, Qiong, 2023. "Cash holdings, ambiguity aversion, and investment puzzles," Economics Letters, Elsevier, vol. 229(C).
    8. Flor, Christian Riis & Hesel, Søren, 2015. "Uncertain dynamics, correlation effects, and robust investment decisions," Journal of Economic Dynamics and Control, Elsevier, vol. 51(C), pages 278-298.
    9. Chen, Yu-Fu & Funke, Michael & Glanemann, Nicole, 2011. "Dark Clouds or Silver Linings? Knightian Uncertainty and Climate Change," SIRE Discussion Papers 2011-64, Scottish Institute for Research in Economics (SIRE).
    10. Agliardi, Elettra & Sereno, Luigi, 2011. "The effects of environmental taxes and quotas on the optimal timing of emission reductions under Choquet–Brownian uncertainty," Economic Modelling, Elsevier, vol. 28(6), pages 2793-2802.
    11. Thijssen, Jacco J.J., 2011. "Incomplete markets, ambiguity, and irreversible investment," Journal of Economic Dynamics and Control, Elsevier, vol. 35(6), pages 909-921, June.
    12. Graeme Guthrie, 2021. "Discounting, Disagreement, and the Option to Delay," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 80(1), pages 95-133, September.
    13. Yu‐Jui Huang & Xiang Yu, 2021. "Optimal stopping under model ambiguity: A time‐consistent equilibrium approach," Mathematical Finance, Wiley Blackwell, vol. 31(3), pages 979-1012, July.
    14. Thijssen, Jacco J.J., 2015. "A model for irreversible investment with construction and revenue uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 57(C), pages 250-266.
    15. Gao, Yongling & Driouchi, Tarik, 2018. "Accounting for ambiguity and trust in partial outsourcing: A behavioral real options perspective," Journal of Business Research, Elsevier, vol. 92(C), pages 93-104.
    16. Arnon Archankul & Giorgio Ferrari & Tobias Hellmann & Jacco J. J. Thijssen, 2023. "Singular Control in a Cash Management Model with Ambiguity," Papers 2309.12014, arXiv.org.
    17. Delaney, Laura, 2022. "The impact of operational delay on irreversible investment under Knightian uncertainty," Economics Letters, Elsevier, vol. 215(C).

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