Investment Timing Under Regime Switching

International Journal of Theoretical and Applied Finance, Vol. 12, No. 4, pp. 443-463, 2009

21 Pages Posted: 16 Apr 2010 Last revised: 9 Feb 2013

See all articles by Robert J. Elliott

Robert J. Elliott

University of Calgary - Haskayne School of Business; University of Alberta - Department of Mathematical and Statistical Sciences; University of South Australia

Hong Miao

Colorado State University, Fort Collins - Department of Finance & Real Estate

Yu Jin

University of New South Wales (UNSW)

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Date Written: January 17, 2008

Abstract

We investigate the optimal investment timing strategy in a real option framework. Depending on the state of the economy, whose changes are modeled by a Markov chain, the investment cost can take one of two values. The optimal investment timing decision is determined by finding the free boundary of a perpetual American option. Three investment timing policies, based on different assumptions of investors' information sets, are determined and compared. In the full information case, a significantly earlier optimal exercising time is indicated. We show that an optimal-timing policy suggested by the conventional real option model might ruin the investment opportunities.

Keywords: Regime Switching, Real Option, Investment Timing

Suggested Citation

Elliott, Robert James and Miao, Hong and Jin, Yu, Investment Timing Under Regime Switching (January 17, 2008). International Journal of Theoretical and Applied Finance, Vol. 12, No. 4, pp. 443-463, 2009, Available at SSRN: https://ssrn.com/abstract=1515481

Robert James Elliott (Contact Author)

University of Calgary - Haskayne School of Business ( email )

2500 University Drive, NW
Calgary, Alberta T2N 1N4
Canada

University of Alberta - Department of Mathematical and Statistical Sciences ( email )

Edmonton, Alberta T6G 2G1
Canada
403-492-5811 (Phone)
403-492-6826 (Fax)

University of South Australia ( email )

37-44 North Terrace
Adelaide
Australia

Hong Miao

Colorado State University, Fort Collins - Department of Finance & Real Estate ( email )

Fort Collins, CO 80523
United States

Yu Jin

University of New South Wales (UNSW) ( email )

Kensington
High St
Sydney, NSW 2052
Australia

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