Investment Timing Under Incomplete Information

41 Pages Posted: 16 Jul 2008

See all articles by Jean-Paul Decamps

Jean-Paul Decamps

University of Toulouse 1 - Toulouse School of Economics (TSE)

Thomas Mariotti

University of Toulouse I

Stephane Villeneuve

University of Toulouse 1 - Toulouse School of Economics (TSE)

Date Written: January 2003

Abstract

We study the decision of when to invest in an indivisible project whose value is perfectly observable but driven by a parameter that is unknown to the decision maker ex ante. This problem is equivalent to an optimal stopping problem for a bivariate Markov process. Using filtering and martingale techniques, we show that the optimal investment region is characterised by a continuous and non-decreasing boundary in the value/belief state space. This generates path-dependency in the optimal investment strategy. We further show that the decision maker always benefits from an uncertain drift relative to an 'average' drift situation. However, a local study of the investment boundary reveals that the value of the option to invest is not globally increasing with respect to the volatility of the value process.

JEL Classification: D20, D80, H11, H70, L22, P11

Suggested Citation

Decamps, Jean-Paul and Mariotti, Thomas and Villeneuve, Stéphane, Investment Timing Under Incomplete Information (January 2003). LSE STICERD Research Paper No. TE444, Available at SSRN: https://ssrn.com/abstract=1160988

Jean-Paul Decamps (Contact Author)

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

1, Esplanade de l'Université
31080 Toulouse Cedex 06
France

Thomas Mariotti

University of Toulouse I ( email )

Toulouse, 31000
France

Stéphane Villeneuve

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France