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
Date Written: January 17, 2008
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
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