Consumption Utility-Based Pricing and Timing of the Option to Invest with Partial Information |
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Authors: | Jinqiang Yang Zhaojun Yang |
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Affiliation: | (1) Institute of Accounting and Taxation, University of Graz, Universitaetsstr. 15/G2, 8010 Graz, Austria |
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Abstract: | This paper extends real options theory to consider the situation where the mean appreciation rate of the value of an irreversible
investment project is not observable and governed by an Ornstein–Uhlenbeck process. Our main purpose is to analyze the impact
of the uncertainty of the mean appreciation rate on the pricing and investment timing of the option to invest under incomplete
markets with partial information. We assume that an investor aims to maximize expected discounted utility of lifetime consumption.
Based on consumption utility indifference pricing method, stochastic control and filtering theory, we obtain under CARA utility
the implied values and the optimal investment thresholds of the option to invest, which are determined by a semi-closed-form
solution to a free-boundary partial differential equation (PDE) problem. The solution is independent of the utility time-discount
rate. We provide numerical results by finite difference methods and compare the results with those under a fully observable
case. Numerical calculations show that partial information leads to a significant loss of the implied value of the option
to invest. This loss, called implied information value, IIV increases quickly with the uncertainty of the mean appreciation rate. A high volatility of project values might decrease
the IIV, as well as the implied value of the option. |
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Keywords: | |
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