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Real options with endogenous convenience yield
Author(s) -
Cheng Yiying,
Clark Steven P.
Publication year - 2019
Publication title -
journal of corporate accounting and finance
Language(s) - English
Resource type - Journals
eISSN - 1097-0053
pISSN - 1044-8136
DOI - 10.1002/jcaf.22390
Subject(s) - futures contract , analogy , yield (engineering) , investment (military) , economics , commodity , control (management) , risk analysis (engineering) , microeconomics , business , financial economics , finance , management , materials science , metallurgy , linguistics , philosophy , politics , political science , law
Traditional real options theory highlights the impact of risk on the timing of investment decisions. However, in practice, corporate projects often involve a preliminary exploratory stage, incurring a running cost and convenience yield. By analogy with commodity futures theories, we model such multistage corporate projects in a feedback‐control framework, with a dynamic aggregate convenience yield/running cost that interacts with the decisions to enter or exit the preliminary stage. We provide a closed‐form solution for this compound options model. The solution provides insight and quantifies of the optimal strategy for prevalent corporate projects with a preliminary exploration stage.