Real Options and the Universal Bad News Principle

34 Pages Posted: 4 May 2004

See all articles by Svetlana Boyarchenko

Svetlana Boyarchenko

University of Texas at Austin - Department of Economics

Sergei Levendorskii

Calico Science Consulting

Date Written: April 20, 2004

Abstract

A general framework for pricing of real options in continuous time for wide classes of payoff streams that are monotone functions of a Levy process is provided. Exercise rules are formulated in terms of statistics of record-setting low payoffs and can be viewed as an extension of Bernanke's bad news principle. To illustrate the framework, we solve analytically the following problems: a capital expansion program when the underlying price exhibits mean reverting features; an entry decision with an option to exit, and a new technology adoption. The effects of industry specific and idiosyncratic risks are separated. The third model is driven by two factors: one describes the dynamics of the frontier technology, the other incorporates non-technological uncertainty. The former factor follows a process with upward jumps. The impact of these factors on new technology adoption is analyzed.

Keywords: Exit and entry, emdebbed options, technology adoption, capital expansion

JEL Classification: D81, C61, G31

Suggested Citation

Boyarchenko, Svetlana I. and Levendorskii, Sergei Z., Real Options and the Universal Bad News Principle (April 20, 2004). Available at SSRN: https://ssrn.com/abstract=533723 or http://dx.doi.org/10.2139/ssrn.533723

Svetlana I. Boyarchenko (Contact Author)

University of Texas at Austin - Department of Economics ( email )

Austin, TX 78712
United States

Sergei Z. Levendorskii

Calico Science Consulting ( email )

Austin, TX
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
202
Abstract Views
1,253
rank
158,431
PlumX Metrics