Toward a Behavioral Theory of Real Options: Noisy Signals, Bias, and Learning

43 Pages Posted: 20 Dec 2014 Last revised: 15 Mar 2020

See all articles by Hart E. Posen

Hart E. Posen

University of Wisconsin-Madison

Michael J. Leiblein

Ohio State University

John S. Chen

University of Florida

Date Written: January 23, 2017

Abstract

We develop a behavioral theory of real options that relaxes the informational and behavioral assumptions underlying applications of financial options theory to real assets. To do so, we augment real option theory’s focus on uncertain future asset values (prospective uncertainty) with feedback learning theory that considers uncertain current asset values (contemporaneous uncertainty). This enables us to incorporate behavioral bias in the feedback learning process underlying the option execution/termination decision. The resulting computational model suggests that firms that inappropriately account for contemporaneous uncertainty and are subject to learning biases may experience substantial downside risk in undertaking real options. Moreover, contrary to the standard option result, greater uncertainty may decrease option value, making commitment to an investment path more effective than remaining flexible.

Keywords: Bayesian Learning, Competitive Advantage, Computational Model, Decision-Making Under Uncertainty, Experiential Learning, Heterogeneity, Real Option Logic, Sequential Decision-Making, Simulation, Strategic Decision-Making

JEL Classification: A10, A12, C11, C15, D80, D81, D83, G10, G11, G31, M20

Suggested Citation

Posen, Hart E. and Leiblein, Michael J. and Chen, John S., Toward a Behavioral Theory of Real Options: Noisy Signals, Bias, and Learning (January 23, 2017). Available at SSRN: https://ssrn.com/abstract=2540214 or http://dx.doi.org/10.2139/ssrn.2540214

Hart E. Posen (Contact Author)

University of Wisconsin-Madison ( email )

Madison, WI
United States

HOME PAGE: http://https://wsb.wisc.edu/directory/faculty/hart-posen

Michael J. Leiblein

Ohio State University ( email )

700 Fisher Hall
2100 Neil Avenue
Columbus, OH 43210-1144
United States
614-292-0071 (Phone)
614-292-7062 (Fax)

John S. Chen

University of Florida ( email )

PO Box 117165, 201 Stuzin Hall
Gainesville, FL 32610-0496
United States

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