Real Options under a Double Exponential Jump-Diffusion Model with Regime Switching and Partial Information

34 Pages Posted: 14 Jun 2010 Last revised: 27 Oct 2015

See all articles by Pengfei Luo

Pengfei Luo

Hunan University - School of Finance and Statistics

Jie Xiong

University of Macau

Jinqiang Yang

Shanghai University of Finance and Economics

Zhaojun Yang

Southern University of Science and Technology - Department of Finance

Date Written: October 27, 2015

Abstract

We consider an irreversible investment in a project, which generates cash flow following a double exponential jump-diffusion process and its expected return is governed by a continuous-time two-state Markov chain. If the expected return is observable, we present explicit expressions for the pricing and timing of the option to invest. With partial information, i.e. if the expected return is unobservable, we provide an explicit project value and an integral-differential equation for the pricing and timing of the option. We show a method to measure the information value, i.e. the difference between the values of the option to invest under the two cases. We present numerical solutions by finite difference methods if jumps are absent. By numerical analysis, we find that: (i) The value of the option to invest increases with the belief on economic boom; (ii) If investors are more uncertain about the state of the economy, information is more valuable; (iii) The more likely the transition from boom to recession, the less the value of the option; (iv) The bigger the dispersion of the expected return, the higher the information value; (v) A higher cash flow volatility induces a less information value.

Keywords: Real options, Partial information, Information value, Double exponential jump-diffusion process

JEL Classification: D11, D91, E21

Suggested Citation

Luo, Pengfei and Xiong, Jie and Yang, Jinqiang and Yang, Zhaojun, Real Options under a Double Exponential Jump-Diffusion Model with Regime Switching and Partial Information (October 27, 2015). Available at SSRN: https://ssrn.com/abstract=1624849 or http://dx.doi.org/10.2139/ssrn.1624849

Pengfei Luo

Hunan University - School of Finance and Statistics ( email )

Shijiachong Road 109#
Changsha, Hunan 410079
China

Jie Xiong

University of Macau ( email )

P.O. Box 3001
Macau

Jinqiang Yang

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, P.R.China, AK Shanghai 200433
China

Zhaojun Yang (Contact Author)

Southern University of Science and Technology - Department of Finance ( email )

No 1088, Xueyuan Rd.
District of Nanshan
Shenzhen, Guangdong 518055
China

HOME PAGE: http://faculty.sustc.edu.cn/profiles/yangzj

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