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Real-Option Valuation in Multiple Dimensions Using Poisson Optional Stopping Times

Published online by Cambridge University Press:  15 January 2019

Rutger-Jan Lange Open the ORCID record for Rutger-Jan Lange [Opens in a new window] ,
Daniel Ralph Open the ORCID record for Daniel Ralph [Opens in a new window]  and
Kristian Støre
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Abstract

We provide a new framework for valuing multidimensional real options where opportunities to exercise the option are generated by an exogenous Poisson process, which can be viewed as a liquidity constraint on decision times. This approach, which we call the Poisson optional stopping times (POST) method, finds the value function as a monotone sequence of lower bounds. In a case study, we demonstrate that the frequently used quasi-analytic method yields a suboptimal policy and an inaccurate value function. The proposed method is demonstrably correct, straightforward to implement, reliable in computation, and broadly applicable in analyzing multidimensional option-valuation problems.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 2 , March 2020 , pp. 653 - 677
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2019 

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Footnotes

1

We thank two anonymous referees, Jan van Casteren, Dick van Dijk, Øystein Gjerde, David Mauer (a referee), and Coen Teulings for helpful comments. We also thank Hendrik Bessembinder (the editor) for his helpful guidance.

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