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Optimal Investment under Cost Uncertainty

Questrom School of Business, Boston University, Boston, MA 02215, USA
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Received: 9 December 2017 / Revised: 9 January 2018 / Accepted: 16 January 2018 / Published: 22 January 2018
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Abstract

This paper studies the valuation of real options when the cost of investment jumps at a random time. Three valuation formulas are derived. The first expresses the value of the project in terms of a collection of knockout barrier claims. The second identifies the premium relative to a project with delayed investment right and prices its components. The last one identifies the premium/discount relative to a project with constant cost equal to the post-jump cost and prices its components. All formulas are in closed form. The behavior of optimal investment boundaries and valuation components are examined. View Full-Text
Keywords: American option; real options; optimal stopping; random strike; early exercise premium; free-boundary problem American option; real options; optimal stopping; random strike; early exercise premium; free-boundary problem
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Detemple, J.; Kitapbayev, Y. Optimal Investment under Cost Uncertainty. Risks 2018, 6, 5.

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