Optimal regulation of lumpy investments

We study optimal timing of regulated investment in a real options setting, in which the regulated monopolist has private information on investment costs. In solving the ensuing agency problem, the regulator trades off investment timing inefficiency against the dead-weight loss arising from high price caps. We show that optimal regulation is implemented by a price cap that decreases as a function of the monopolist’s chosen investment time.     

Real options and demographic decisions

The theory of real options is used to incorporate the influence of uncertainty on demographic decision-making. The decision to have children is formulated as an investment using portfolio theory. The timing of the decision to have a child is modelled as a real options decision, with uncertainty affecting a woman's ability to exercise the ‘option to wait’ in order to delay or space births. An increase and reduction in uncertainty on this option is explored. Compared to the widely used net present value (NPV) framework, the real options approach (ROA) better explains the process of demographic decision-making in poor countries.     

Real Options Effects on Employment: Does Exchange Rate Uncertainty Matter for Aggregation?

Abstract. In a baseline micro model a band of inaction due to hiring and firing costs is widened by option value effects of exchange rate uncertainty. Based on this micro foundation, an aggregation approach is presented. Under uncertainty, intervals of weak response to exchange rate reversals (called ‘play’ areas) are introduced on the macro level. ‘Spurts’ in new employment or firing may occur after an initially weak response. Since these mechanisms may apply to other ‘investment’ cases where the aggregation of microeconomic real options effects under uncertainty are relevant, they may even be of a more general interest.     

Housing price fluctuations and financial risk transmission: a spatial economic model

Financial risk derived from housing price fluctuations in China garnered much public concern recently. Based on the theoretical analyses of the transmission of financial risk from housing price fluctuations, this paper establishes panel spatial Durbin models to empirically analyse housing price fluctuations and financial risks transmission from a spatial economic perspective. Employing the panel provincial data from 1999–2015, we conduct an analysis on the 30 provinces in China as well as a comparison among the Eastern, Middle and Western regions of China. The results indicate that: (1) The soaring housing prices driven by bank credit, real estate developers’ heavy investment, local governments’ land revenue and individuals and households demands leads to financial risk in various sectors; (2) due to the ‘substitution effect’, the capital agglomeration in metropolis from bank credits, real estate developers, and individuals and households furthers the amassment of financial risks; (3) housing prices have a significant spatial contagion effect throughout the country, and financial risk could directly transmit across provinces through housing price fluctuations; (4) financial risks could indirectly transmit across provinces via the ‘imitative behaviour’ or ‘driving effect’ of different sectors for different regions of China.     

Options in technology investment games: The real world TFT-LCD industry case

The Thin Film Transistor-Liquid Crystal Display (TFT-LCD) industry has demonstrated that the investment of huge amounts of capital in new plants is a key factor for success. Decisions about investing in the latest generation of plant involve billions of dollars and a great deal of uncertainty. Moreover, the industry shows distinct oligopolistic characteristics, so the first mover's reactions must be considered when making capital decisions in such competitive environments. The traditional net present value (NPV) rule is a ‘now-or-never’ concept that fails to capture the need for managerial flexibility, which is especially important when investments are irreversible and involve a great deal of uncertainty. In this paper, we use a combination of real options and game theory to analyze the investment strategies of a case company in the TFT-LCD industry. The results show that real options reveal the value of flexibility, which NPV fails to consider. In addition, we apply game theory analysis to different investment strategies to demonstrate the decision-making processes used by competing companies.     

Real options as a component of the market value of stocks: evidence from the Spanish Stock Market

This paper aims to examine how investors’ expectations about the value of a firm's real options are reflected in the price of its stocks. If the real-option approach is correct, then the efficient-market hypothesis predicts that stock prices will reflect the available information relative to the real options held by firms and their ability to identify, acquire, maintain and exercise them. The role of investment irreversibility, operating and financial flexibility, business and geographical diversification, and size are examined as indicators of a firm's real option strategy. The empirical analysis of a panel of 101 companies listed on the Spanish Stock Exchange during the period 1991–1997 provides evidence consistent with predictions. The market value of the real option portfolio is significantly and positively related to business diversification, asset irreversibility and operating leverage, and negatively related to size. In addition, financial leverage and geographical diversification are not significantly related to our proxies for the market value of real options. These results are robust even after controlling for industry, and alternative measures of investment flexibility and business diversification.     

Resource depletion under uncertainty: implications for mine depreciation,Hartwick’s Rule and national accounting

Lozada’s equation [Resource and Energy Economics 17 (1995) 137] for the change in value of a non-autonomous dynamic program is generalized to stochastic control and applied to the depreciation of a competitive mine facing price, reserve and discount rate uncertainty. Mine depreciation includes the costs of these risks, as well as an adjustment to the ‘net price’ used to value depletion and revisions. The change in value equation also provides the basis for a stochastic version of Hartwick’s Rule [American Economic Review 67 (1977) 972] for sustainable consumption, that the risk adjusted value of net investment equal zero. The analysis has implications for the Weitzman [Quarterly Journal of Economics 90 (1976) 156] welfare measure and the stochasic Hamiltonian.     

复合嵌套实物期权的定价应用研究

传统的项目投资价值分析方法不能满足对不确定性较高的项目进行定价的要求,而实物期权定价方法由于具有诸如能识别出在不确定环境中投资决策者管理灵活性价值等优点,得到广泛运用。复合嵌套实物期权模型更能贴切地反映在实际项目中具有的多重期权的特性,因而更成为研究热点。基于战略投资的长周期性与分阶段性等特点,将最早用于金融期权定价的Geske模型经过改进后的复合嵌套实物期权模型,更能将战略投资中管理灵活性的价值识别出来,因此更适于对战略投资项目进行定价。本文对基于复合期权的战略投资定价模型的模型设定、假设、参数设定、参数意义进行了细致阐述,以提高其实用性。     

The game analyses to price the target enterprise of merger and acquisition based on the perspective of real options under stochastic surroundings

Although several approaches have been developed to evaluate the target enterprise of merger and acquisition (M&A) such as classical net present value (NPV) evaluation model and real options techniques, the logic of pricing processes in all these approaches is still faulty. The classical approach of NPV perspective to price the target enterprise of M&A has been replaced by integration of contemporary perspectives such as NPV perspective, real options perspective, game perspective, and so on. In this paper, the dynamic analyses model to price the target enterprise of M&A is developed from the perspective of real options integrated with game theory under stochastic surroundings. The synergy multiplication coefficient is introduced into the evaluation model to reflect the synergy management process of M&A, and the equilibrium price formula is proposed by applying the famous offer-counteroffer Rubinstein theorem, which is improved to fit for the stochastic surroundings. The price formula is further discussed on condition that the operating cost is more than or less than profit flow, which is assumed to follow geometric Brownian motion process. The numeric simulations show that the proposed formulas in this paper can perfectly well reflect the realistic practice of M&A.     

Capital Gains and Income Arising from Nonrenewable Resources

Should capital gains be included in income arising from nonrenewable resources? In the present paper, I show that capital gains from a nonrenewable resource can be divided into two terms: real price change effects and real interest rate change effects. By application of sectoral income theory developed by Asheim and Wei (Environ Res Econ 42:65–87, 2009), only the former term is part of real income of the resource and the latter term should not be included. This result is significant in the sense that all change in real resource wealth can be included as part of real income only if future real interest rates are assumed to be constant. Hotelling rule always implies that capital gains from nonrenewable resources coincide with real interests on resource wealth; net investment generated from the resource cancels out current cash flow from the resource; and real income comes from price change effects.     

Joan Robinson as a teacher

Sraffa's construct, the standard commodity, responds to Ricardo's search for an ‘invariable’ measure of value, since it is a measurement unit invariant to changes in distribution. But Sraffa suggests that there is no ‘counterpart,’ no analogous search or needed construct, for the ‘problem’ of ‘difference’ as distinct from change (‘why two commodities produced by the same quantities of labour are not of the same exchangeable value’). Difference in this sense is crucial to Marx, who distinguishes value and surplus-value from capitalist price and profit in part in order to theorize differences as systematic value transfers. In that effort, Marx repeatedly poses commodities and capitals as ‘aliquot parts’ of the whole, so that profit is a redistributed share of aggregate surplus-value. This paper shows that, when Marx's aliquot part imagery is formalized, the resulting hypothetical system represents a meaningful ‘counterpart,’ a construct with a function in Marx's analysis of difference comparable to that of Sraffa's standard commodity in analyzing distributional change. A Marxian ‘standard system’ posing each commodity as an aliquot part of the social capital (a) defines the needed labor-time unit of social account by homogenizing heterogeneous concrete labors as socially average (‘abstract’) labor while simultaneously (b) allowing the derivation of exchange-value (e.g., capitalist production price) on that scale via summation of directly and indirectly embodied labor. Indeed, Marx's approach to production prices as resulting from an inter-industry redistribution of aggregate surplus-value is shown to be algebraically identical to the calculation of labor-embodied under ‘aliquot part’ production conditions.     

Liquidity default,liquidity management and smooth dividends policy

Our article models liquidity financing constraints with the real options framework. By conducting a comprehensive investigation of the effects of shocks to liquidity constraints on the firm’s optimal investment, financing and dividend policies, our model highlights the importance of liquidity management and extends the liquidity management approach to hedge liquidity default risk. We find that being concerned about liquidity default risk will significantly change a firm’s behaviours, including those related to investment and the optimal capital structure. A firm that is concerned about its liquidity default risk will become more cautious: it will choose to delay investment and have higher leverage when internal liquidity is very low, but choose earlier investment and lower leverage when liquidity is high enough. The dividends policy can alleviate risks from both the external market and internal project volatility and provides an alternative explanation for the ‘smooth dividends policy puzzle’ commonly reported in empirical research.     

PRACTICAL GUIDE TO REAL OPTIONS IN DISCRETE TIME*

Continuous time models in the theory of real options give explicit formulas for optimal exercise strategies when options are simple and the price of an underlying asset follows a geometric Brownian motion. This article suggests a general, computationally simple approach to real options in discrete time. Explicit formulas are derived even for embedded options. Discrete time processes reflect the scarcity of observations in the data, and may account for fat tails and skewness of probability distributions of commodity prices. The method of this article is based on the use of the expected present value operators.     

Fiscal Adjustment, The Real Exchange Rate and Australia's External Imbalance

This article examines issues of relevance to Australia's external imbalance. We investigate the sharp fiscal consolidation over the past five years and examine why it did not reduce the current account deficit. We show that a disproportionate part of the fiscal consolidation was achieved by cutting public investment spending, and we discuss some of the negative consequences of such cuts. We compare the macroeconomic behaviour of six OECD countries which have recently increased net government savings. It has been a common experience that an increase in net government saving has not been associated with a reduction in the current account deficit. For Australia, we establish that the link between fiscal consolidation and a smaller current account deficit was severed by a private sector investment surge. This leads us to examine the behaviour of the relative price critical to the allocation of this investment between the traded and non-traded sectors - the real exchange rate. Over the medium term, we argue that a substantial real depreciation is necessary as part of the adjustment required to stabilise the ratio of net external liabilities to GDP.     

实物期权方法在BOT公路投资项目中的应用

投资项目具有多种期权特性,传统的DCF评价方法无法评估多个不确定性对投资项目的影响。实物期权方法为决策者提供了一个有效管理不确定性因素的工具。国内外学者就BOT公路投资项目中的增长期权、延迟期权、投资扩张、政府保证、特许权期限调整、通行费率调整、投资成本和车流量不确定性等多个问题进行了大量的讨论。本文首先对实物期权理论在BOT公路投资项目方面的应用研究进行文献回顾,然后详细的分析了国内BOT公路投资项目收益的不确定性、项目投资的可延迟性、项目的可扩建性、政府的保证以及项目特有的土地开发及广告收益等多个特点具有的期权价值。并对这些期权的定价模型进行了简要的介绍。文章最后对运用实物期权理论应用过程中的难点进行了分析,并在此基础上总结实物期权理论在BOT公路投资项目中应用的研究方向。     

Inflation,tax rules,and the prices of land and gold

Traditional theory implies that the relative price of consumer goods and of such real assets as land and gold should not be permanently affected by the rate of inflation. A change in the general rate of inflation should, in equilibrium, cause an equal change in the rate of inflation for each asset price. The experience of the past decade has been very different from the predictions of this theory: the prices of land, gold, and other such stores of value have increased by substantially more than the general price level. The present paper presents a simple theoretical model that explains the positive relation between the rate of inflation and the relative price of such real assets. More specifically, in an economy with an income tax, an increase in the expected rate of inflation causes an immediate increase in the relative price of such ‘store of value’ real assets. The behavior of real asset prices discussed in this paper is thus a further example of the non-neutral response of capital markets to inflation in an economy with income taxes.     

Real option value and random jumps: application of a simulation model

This article studies how sensitive real option valuations are to incorrect assumptions about the stochastic process followed by the state variables. We design a valuation model which combines Monte Carlo simulation and dynamic programming and provides an appropriate framework to evaluate the effect of estimation errors on both the value of real options and their critical frontier. Although the model is flexible enough to value American-type options contingent on a wide range of stochastic processes, we focus on the analysis of the effect of stochastic jumps. We apply our model to the valuation of an investment in the car parts industry documented in previous literature. Our results clearly show that underestimating this type of jumps might lead to substantial misjudgements in a firm's decision-making processes. For instance, it may lead to profitable projects being rejected when jump diffusion is low, or negative expanded net present value projects being accepted.     

Evaluating natural resource projects with embedded options and limited reserves

This study proposes a Dynamic Option Simulation (DOS) approach to evaluate natural resource investment projects that contain several embedded options and limited reserves. To construct a practical pricing model, DOS combines simulation and dynamic programming techniques that can value natural resource investments with multi-variable, early exercise, various embedded options and finite reserve properties. A copper mine project offers a demonstration; the mine holder may temporarily close, reopen and abandon the mine at specific times before the expiration date. The mine holder may also accelerate mining speed to be optimal, referred to as the acceleration option. Numerical analyses of the copper price and interest rate effects on the copper mine value suggest that DOS can efficiently assess complex, multiple-variable, American-style real options problems.     

PoJjcy and the Australian Economy, 1977

At the end of the first quarter of 1977 the available economic indicators, while as usual far from univocal, still give cause for serious concern about the health and direction of the Australian economy. With no significant expansionary factors operating in the economy in 1977 other than the revival in the mining industry and in some aspects of business investment, and the various arms of economic policy being set almost entirely in a restrictive stance, aggregate output would appear to be either flat or declining modestly at the present time. On the basis of a continuation of present policies we would anticipate growth in real non-farm GDP of only 2 to 3 per cent in both 1976–77 and 1977–78, with unemployment continuing to increase until well into 1978. Given the stimulus to inflation arising from the 1976 devaluation and from the wage effects of the Medibank changes, the rate of increase in the consumer price index would seem likely to be 14 to 15 per cent in 1977, even if a partial wage indexation policy could be sustained and whether or not a one quarter wage/price deferment comes into effect. But government pressure on the Arbitration Commission for a reduction in real wages has placed the wage indexation system in jeopardy, and there is now considerable uncertainty about the methods of wage fixation which will obtain in 1977–78. This article surveys some aspects of recent developments and considers some policy options available to the government.     

Modelling investment and disinvestment decisions under competition,uncertainty and different market interventions

A real options market model is developed, which derives the firms' optimal investment and disinvestment thresholds simultaneously in a competitive environment. It combines genetic algorithms and stochastic simulation, whereby vast modelling flexibility is gained. For example, different market interventions can be integrated and their effects on the firms' investment behaviour and the sectoral welfare can be assessed. The model is validated for its application to competitive markets by numerically replicating the optimality property of myopic planning. According to the results, production ceilings and investment subsidies are preferable to price floors because the welfare is less reduced for a given stimulation of the willingness to invest. Moreover, it is shown that not considering disinvestment options, which in reality often exist, can lead to incorrect valuations of investment strategies at firm level and incorrect policy impact analyses at macroeconomic level.