Abstract
Ever since the first attempts to model capital investment decisions as options, financial economists have sought more accurate, more realistic real options models. Strategic interactions and market incompleteness are significant challenges that may render existing classical models inadequate to the task of managing the firm’s capital investments. The purpose of this paper is to address these challenges. The issue of incompleteness comes in for the valuation of payoffs due to absence of a unique martingale measure. One approach is to valuate assets by considering a rational utility-maximizing consumer/investor’s joint decisions with respect to portfolio investment strategy and consumption rule. In our situation, we add the stopping time as an additional decision. We employ variational inequalities (V.I.s) to solve the optimal stopping problems corresponding to times to invest. The regularity of the obstacle (payoffs received at the decision time) is a major element for defining the optimal strategy. Due to the lack of smoothness of the obstacle raised by the game problem, the optimal strategy is a two-interval solution, characterized by three thresholds.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Notes
- 1.
M ε is defined as: \(\displaystyle{M_{\varepsilon}=\frac{\big (\frac{\delta_2}{\varepsilon}-r+\alpha-\lambda\varsigma\rho\big )^2}{2\varsigma^2r^2\gamma(1-\rho^2)}}\). If r+λςρ−α>0, we can take M ε =0, hence \(\varepsilon =\frac{\delta_{2}}{r-\alpha+\lambda\varsigma\rho}\). Note that ε can be arbitrarily small.
- 2.
- 3.
For any test function Ψ(x,s), we have the formula:
(32) - 4.
See footnote 1 for the definition of M ε .
- 5.
Here Y y (t) is the process defined in (2).
- 6.
References
Bensoussan, A.: Applications of Variational Inequalities in Stochastic Control. Elsevier/North-Holland, Amsterdam (1978)
Bensoussan, A., Diltz, J.D., Hoe, S.: Real options games in complete and incomplete markets with several decision makers. SIAM J. Financ. Math. 1(1), 666–728 (2010)
Dixit, A., Pindyck, R.S.: Investment Under Uncertainty. Princeton University Press, Princeton (1994)
Grenadier, S.: The strategic exercise of options: development cascades and overbuilding in real estate markets. J. Finance 51(5), 1653–1679 (1996)
Kinderlenher, D., Stampacchia, G.: An Introduction to Variational Inequalities and Their Applications. Academic Press, San Diego (1980)
Acknowledgement
The first author acknowledges support of National Science Foundation DMS-1303775 and of the Research Grants Council of HKSAR (CityU 500113).
Author information
Authors and Affiliations
Corresponding author
Editor information
Editors and Affiliations
Rights and permissions
Copyright information
© 2014 Springer International Publishing Switzerland
About this chapter
Cite this chapter
Bensoussan, A., Hoe, S.(. (2014). Real Options with Competition and Incomplete Markets. In: Kabanov, Y., Rutkowski, M., Zariphopoulou, T. (eds) Inspired by Finance. Springer, Cham. https://doi.org/10.1007/978-3-319-02069-3_2
Download citation
DOI: https://doi.org/10.1007/978-3-319-02069-3_2
Publisher Name: Springer, Cham
Print ISBN: 978-3-319-02068-6
Online ISBN: 978-3-319-02069-3
eBook Packages: Mathematics and StatisticsMathematics and Statistics (R0)