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Investment Decisions with Two-Factor Uncertainty

Author

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  • Compernolle, T.
  • Huisman, Kuno

    (Tilburg University, Center For Economic Research)

  • Kort, Peter M.

    (Tilburg University, Center For Economic Research)

  • Lavrutich, Maria

    (Tilburg University, Center For Economic Research)

  • Nunes, Claudia
  • Thijssen, J.J.J.

    (Tilburg University, Center For Economic Research)

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.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Compernolle, T. & Huisman, Kuno & Kort, Peter M. & Lavrutich, Maria & Nunes, Claudia & Thijssen, J.J.J., 2018. "Investment Decisions with Two-Factor Uncertainty," Discussion Paper 2018-003, Tilburg University, Center for Economic Research.
    • Handle: RePEc:tiu:tiucen:9e05d125-86f6-4549-9d49-9b73bcdae3fd
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    References listed on IDEAS

    as
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    3. De Weerdt, Loïc & Oliveira, Carlos & Larson, Eric D. & Greig, Chris, 2023. "The interplay between technology options, market uncertainty, and policy in zero-carbon investment decisions," Energy Economics, Elsevier, vol. 128(C).
    4. Zhang, Xinhua & Hueng, C. James & Lemke, Robert J., 2023. "Using a price floor on carbon allowances to achieve emission reductions under uncertainty," Economic Analysis and Policy, Elsevier, vol. 80(C), pages 1096-1110.
    5. Esparcia, Carlos & Jareño, Francisco & Umar, Zaghum, 2022. "Revisiting the safe haven role of Gold across time and frequencies during the COVID-19 pandemic," The North American Journal of Economics and Finance, Elsevier, vol. 61(C).
    6. Lorenzo Nalin & Giuliano Toshiro Yajima, 2021. "Commodities fluctuations, cross border flows and financial innovation: A stock‐flow analysis," Metroeconomica, Wiley Blackwell, vol. 72(3), pages 539-579, July.
    7. Li, Li & Wang, Shuai & Wu, Jiaqi & Sun, Zhenqing, 2024. "Exploring the efficacy of renewable energy support policies in uncertain environments: A real options analysis," Energy Economics, Elsevier, vol. 132(C).
    8. Felix Dammann & Giorgio Ferrari, 2021. "On an Irreversible Investment Problem with Two-Factor Uncertainty," Papers 2103.08258, arXiv.org, revised Jul 2021.
    9. Dammann, Felix & Ferrari, Giorgio, 2021. "On an Irreversible Investment Problem with Two-Factor Uncertainty," Center for Mathematical Economics Working Papers 646, Center for Mathematical Economics, Bielefeld University.

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    Keywords

    investment analysis; optimal stopping time problem; two-factor uncertainty;
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