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A Note On Irreversible Investment, Hedging And Optimal Consumption Problems

Author

Listed:
  • VICKY HENDERSON

    (Bendheim Center for Finance and ORFE, Princeton University, Princeton, NJ 08544, USA)

  • DAVID HOBSON

    (Department of Mathematical Sciences, University of Bath, Bath, BA2 7AY, UK)

Abstract

A canonical problem in real option pricing, as described in the classic text of Dixit and Pindyck [2], is to determine the optimal time to invest at a fixed cost, to receive in return a stochastic cashflow. In this paper we are interested in this problem in an incomplete market where the cashflow is not spanned by the traded assets. We follow the formulation in Miao and Wang [21]; our contribution is to show that significant progress can be made in solving the Hamilton-Jacobi-Bellman equation and that the optimal exercise threshold can be characterized quite precisely.

Suggested Citation

  • Vicky Henderson & David Hobson, 2006. "A Note On Irreversible Investment, Hedging And Optimal Consumption Problems," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 9(06), pages 997-1007.
    • Handle: RePEc:wsi:ijtafx:v:09:y:2006:i:06:n:s021902490600386x
    DOI: 10.1142/S021902490600386X
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    References listed on IDEAS

    as
    1. Miao, Jianjun & Wang, Neng, 2007. "Investment, consumption, and hedging under incomplete markets," Journal of Financial Economics, Elsevier, vol. 86(3), pages 608-642, December.
    2. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
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