Learning to Wait: A Laboratory Investigation

40 Pages Posted: 13 Oct 2008

See all articles by Daniel Friedman

Daniel Friedman

University of California, Santa Cruz - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Ryan Oprea

University of California, Santa Cruz

Steven T. Anderson

affiliation not provided to SSRN

Date Written: August 21, 2007

Abstract

An irreversible investment opportunity has value V governed by Brownian motion with upward drift and random expiration. Human subjects choose in continuous time when to invest. If she invests before expiration, the subject receives V C: the final value V less a given avoidable cost C. The optimal policy is to invest when V first crosses a threshold V = (1 w )C , where the option premium w is a specific function of the Brownian parameters representing drift, volatility and discount (or expiration hazard) rate. We ran 80 periods each for 69 subjects. Subjects in the Low w treatment on average invested at values quite close to optimum. Subjects in the two Medium and the High w treatments invested at values below optimum, but with the predicted ordering, and values approached the optimum by the last block of 20 periods. Behavior was most heterogeneous in the High treatment. Subjects underrespond to differences in both the volatility and expiration hazard parameters. A directional learning model suggests that subjects react reliably to ex-post losses due to early investment, but react more strongly to missed investment opportunities. Simulations show that this unbalanced learning process converges on a nearly optimal steady state.

Keywords: Real options, deferral option, wait option, optimal stopping, laboratory experiments

JEL Classification: G13, D83, C91

Suggested Citation

Friedman, Daniel and Oprea, Ryan and Anderson, Steven T., Learning to Wait: A Laboratory Investigation (August 21, 2007). Available at SSRN: https://ssrn.com/abstract=1282240 or http://dx.doi.org/10.2139/ssrn.1282240

Daniel Friedman (Contact Author)

University of California, Santa Cruz - Department of Economics ( email )

Social Sciences I
Santa Cruz, CA 95064
United States
831-459-4981 (Phone)
831-459-5900 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Ryan Oprea

University of California, Santa Cruz ( email )

1156 High St
Santa Cruz, CA 95064
United States

Steven T. Anderson

affiliation not provided to SSRN ( email )

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