Working Paper: NBER ID: w12990
Authors: Kristian R. Miltersen; Eduardo S. Schwartz
Abstract: We develop a new approach to dealing with real options problems with uncertain maturity. This type of situation is typical for R&D investments and mine or oil exploration projects. These types of projects are characterized by significant on-going investment costs until completion. Since time to completion is uncertain, the total investment costs will also be uncertain. Despite the fact that these projects include complicated American abandonment/switching options until completion and European options at completion (because of fixed final investment costs) we obtain simple closed form solutions. We apply the framework to situations in which the owner of the project has monopoly rights to the outcome of the project, and to situations in which there are two owners who simultaneously invest, but where only one of them may obtain the rights to the outcome. We expand the real options framework to incorporate game theoretic considerations, including a generalization of mixed strategies to continuous-time models in the form of abandonment intensities.
Keywords: real options; uncertain maturity; competition
JEL Codes: G13; G31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Uncertain maturity (D25) | Increased ongoing investment costs (G31) |
| Uncertain maturity (D25) | Increased valuation complexity (G19) |
| Ongoing costs and expected outcomes (I21) | Project viability (O22) |
| Competition (L13) | Valuation of investment outcomes (G11) |
| Completion of one project (O22) | Valuation of others (D46) |
| Players' optimal strategies (C72) | Competitors' actions (L13) |