A Model for Wind Farm Management with Option Interactions

56 Pages Posted: 5 Dec 2019 Last revised: 9 Jun 2021

See all articles by Alain Bensoussan

Alain Bensoussan

University of Texas at Dallas - Naveen Jindal School of Management; Hong Kong Polytechnic University - Faculty of Business; Ajou University

Benoit Chevalier-Roignant

Cranfield School of Management

Alejandro Rivera

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

Date Written: November 4, 2019

Abstract

A renewable energy asset manager can expand the power generation capacity of a particular site by an endogenous amount but may also want to shut down the location to save on fixed operating costs if the market prospects deteriorate. The site manager does not exercise these real options in a set sequence: the decision to exit is driven by the value of a capacity expansion option, while the decision to expand depends on the value of an exit option. From our analysis, we obtain three main economic insights. First, the presence of fixed costs renders the NPV threshold nonmonotonic in the firm's existing capacity. Second, the manager further delays shutting down production to avoid killing the expansion option. Finally, it is optimal to delay the timing \emph{and} the scale of the investment in capacity compared to the case without an exit option. Mathematically, we solve a nonstandard optimal stopping problem as the sequence of stopping times is at the discretion of the decision-maker and the objective of the capacity choice problem is not concave, which leads to a gain function that is not differentiable. We find a continuously differentiable solution to this optimal stopping problem and specify the corresponding continuation and stopping sets analytically.

Keywords: Portfolios of real options, compound options, capacity investment, strategic path dependency

Suggested Citation

Bensoussan, Alain and Chevalier-Roignant, Benoit and Rivera, Alejandro, A Model for Wind Farm Management with Option Interactions (November 4, 2019). Available at SSRN: https://ssrn.com/abstract=3480754 or http://dx.doi.org/10.2139/ssrn.3480754

Alain Bensoussan

University of Texas at Dallas - Naveen Jindal School of Management ( email )

800 West Campbell Rd
SM 30
Richardson, TX 75080-3021
United States
9728836117 (Phone)

HOME PAGE: http://www.utdallas.edu/~axb046100/

Hong Kong Polytechnic University - Faculty of Business

Dept SEEM
Systems Engr * Engr Mgmt
Hong Kong, Hong Kong
China

Ajou University ( email )

Ajou
France

Benoit Chevalier-Roignant

Cranfield School of Management ( email )

Cranfield
Bedfordshire MK43 OAL, MK43 0AL
United Kingdom

Alejandro Rivera (Contact Author)

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email )

2601 North Floyd Road
P.O. Box 830688
Richardson, TX 75083
United States

HOME PAGE: http://jindal.utdallas.edu/faculty/alejandro-rivera

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