Exercising Real Options Sooner or Later? New Insights from Quantile-Preserving Spreads on how to Hasten or Delay Exercise

50 Pages Posted: 28 Sep 2021

See all articles by Sang Baum Kang

Sang Baum Kang

Illinois Institute of Technology - Stuart School of Business

Pascal Letourneau

University of Wisconsin - Whitewater

Date Written: September 28, 2021

Abstract

Using Quantile-Preserving Spreads and Stochastic Dominance, this paper studies how modifying a real option's characteristic affects the real option holding value and optimal exercise decision. We find that the direction of change in exercise probability and timing depends on the preserved quantile, strike price, time of underlying modification, and whether a modification is symmetric or not. We significantly generalize previously obtained results to an unspecified underlying process and a general call-like payoff function. Our propositions and corollaries apply to various real option and economic policy problems. Specifically, the results are useful to determine a modification of a real option to increase or decrease its exercise probability and timing.

Keywords: Real Option, Financial Option, Exercise Probability, Quantile-preserving Spread, Stochastic Dominance, Capital Investment

JEL Classification: G12, G31, G32

Suggested Citation

Kang, Sang Baum and Letourneau, Pascal, Exercising Real Options Sooner or Later? New Insights from Quantile-Preserving Spreads on how to Hasten or Delay Exercise (September 28, 2021). Available at SSRN: https://ssrn.com/abstract=3932587 or http://dx.doi.org/10.2139/ssrn.3932587

Sang Baum Kang (Contact Author)

Illinois Institute of Technology - Stuart School of Business ( email )

565 W Adams St
Room 454
Chicago, IL
United States
312-906-6577 (Phone)

Pascal Letourneau

University of Wisconsin - Whitewater ( email )

Whitewater, WI 53190
United States

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