Investment Decisions with Two-Factor Uncertainty
CentER Discussion Paper Series No. 2018-003
21 Pages Posted: 13 Feb 2018
Date Written: October 6, 2017
This paper considers investment problems in real options with non-homogeneous two-factor uncertainty. It shows that, despite claims made in the literature, the method used to derive an analytical solution in one dimensional problems cannot be straightforwardly extended to problems with two stochastic processes. To illustrate, we analyze an investment problem with two stochastic revenue streams and a constant sunk cost. We show that a semi-analytical approach leads to a sub-optimal investment policy. The main message of our paper is that non-homogeneous investment problems can only be solved numerically.
Keywords: Investment analysis; Optimal stopping time problem; Two-factor uncertainty
JEL Classification: C65, D81, L12
Suggested Citation: Suggested Citation