An Experimental Study on Real Option Strategies

Quantitative Finance, 12(11), 1753-1772

Swiss Finance Institute Research Paper No. 09-50

41 Pages Posted: 25 Jan 2010 Last revised: 6 Jan 2016

See all articles by Mei Wang

Mei Wang

WHU - Otto Beisheim School of Management

Abraham Bernstein

University of Zurich - Dynamic and Distributed Information Systems Group

Marc Chesney

University of Zurich - Department of Banking and Finance

Date Written: September 3, 2011

Abstract

We conduct a laboratory experiment to study whether people intuitively use real-option strategies in a dynamic investment setting. The participants were asked to play as an oil manager and make production decisions in response to a simulated mean-reverting oil price. Using cluster analysis, participants can be classifi ed into four groups, which we label as "mean-reverting,"Brownian motion real-option," "Brownian motion myopic real-option," and "ambiguous." We find two behavioral biases in the strategies by our participants: ignoring the mean-reverting process, and myopic behavior. Both lead to too frequent switches when compared with the theoretical benchmark. We also find that the last group behaved as if they have learned to incorporate the true underlying process into their decisions, and improved their decisions during the later stage.

Keywords: Real Option, Experimental Economics, Heterogeneity

JEL Classification: C91, D84, G11

Suggested Citation

Wang, Mei and Bernstein, Abraham and Chesney, Marc, An Experimental Study on Real Option Strategies (September 3, 2011). Quantitative Finance, 12(11), 1753-1772; Swiss Finance Institute Research Paper No. 09-50. Available at SSRN: https://ssrn.com/abstract=1534506 or http://dx.doi.org/10.2139/ssrn.1534506

Mei Wang (Contact Author)

WHU - Otto Beisheim School of Management ( email )

Burgplatz 2
Vallender, 56179
Germany

Abraham Bernstein

University of Zurich - Dynamic and Distributed Information Systems Group ( email )

Plattenstrasse 14
Zurich
Switzerland

Marc Chesney

University of Zurich - Department of Banking and Finance ( email )

Rämistrasse 71
Zürich, CH-8006
Switzerland

HOME PAGE: http://https://www.bf.uzh.ch/en/persons/chesney-marc

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