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Quantitative Finance > Mathematical Finance

Title: Technical Uncertainty in Real Options with Learning

Abstract: We introduce a new approach to incorporate uncertainty into the decision to invest in a commodity reserve. The investment is an irreversible one-off capital expenditure, after which the investor receives a stream of cashflow from extracting the commodity and selling it on the spot market. The investor is exposed to price uncertainty and uncertainty in the amount of available resources in the reserves (i.e. technical uncertainty). She does, however, learn about the reserve levels through time, which is a key determinant in the decision to invest. To model the reserve level uncertainty and how she learns about the estimates of the commodity in the reserve, we adopt a continuous-time Markov chain model to value the option to invest in the reserve and investigate the value that learning has prior to investment.
Comments: Originally posted Oct 6 2014 on SSRN at this http URL
Subjects: Mathematical Finance (q-fin.MF)
Cite as: arXiv:1803.05831 [q-fin.MF]
  (or arXiv:1803.05831v2 [q-fin.MF] for this version)

Submission history

From: Ali Al-Aradi [view email]
[v1] Thu, 15 Mar 2018 16:09:14 GMT (595kb,D)
[v2] Fri, 16 Mar 2018 14:05:51 GMT (595kb,D)