American Economic Review
ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)
Irreversible Decisions and Record-Setting News Principles
American Economic Review
vol. 94,
no. 3, June 2004
(pp. 557–568)
Abstract
In the now-classical real options theory, the price of an underlying asset is modeled as a geometric Brownian motion, and optimal exercise strategies are described by simple explicit formulas. This paper extends the classical theory to allow any geometric Le´vy process to model prices. Such processes may account for fat tails and skewness of probability distributions of commodity prices. The optimal exercise strategies are specified in the paper in terms of statistics of record-setting low or high prices. The formulas derived extend those observed in the Gaussian case, but the form of the result is novel even for that case.Citation
Boyarchenko, Svetlana. 2004. "Irreversible Decisions and Record-Setting News Principles." American Economic Review, 94 (3): 557–568. DOI: 10.1257/0002828041464452JEL Classification
- D31 Personal Income, Wealth, and Their Distributions
- D81 Criteria for Decision-Making under Risk and Uncertainty
- D25 Intertemporal Firm Choice: Investment, Capacity, and Financing
- G13 Contingent Pricing; Futures Pricing; option pricing