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THE CAPITAL MARKET VALUE OF A MULTIPERIOD INVESTMENT WITH THE OPTION OF PREMATURE ABANDONMENT
Author(s) -
Marshall William
Publication year - 1981
Publication title -
decision sciences
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.238
H-Index - 108
eISSN - 1540-5915
pISSN - 0011-7315
DOI - 10.1111/j.1540-5915.1981.tb00113.x
Subject(s) - abandonment (legal) , economics , variance (accounting) , value (mathematics) , asset (computer security) , microeconomics , investment (military) , econometrics , actuarial science , mathematics , computer science , statistics , accounting , computer security , politics , political science , law
Conventional approaches to determining optimal abandonment of a project under uncertainty either assume risk‐neutrality or impose a mean‐variance criterion. Risk‐neutrality is unrealistic while the mean‐variance criterion precludes determination of the optimal strategy without consideration of covariances of returns among projects. Further, the use of variance of present value as a risk measure may result in the “optimality” of a time 0 strategy that involves maintaining a position at time t that will be “suboptimal” and would not be maintained. The use of the multiperiod capital asset pricing model (CAPM) as a decision criterion is consistent with contemporary theory of market behavior and remedies the deficiencies of the mean‐variance approach noted above. Computationally, the optimal strategy for abandonment, when the commitment must be made at time 0 (a lease, say), can be determined with little difficulty beyond that of mean‐variance models. When time of abandonment can remain unspecified, the value of the prospect that abandonment will occur at the optimal time can be determined, though the technique necessary is considerably more complicated. In both cases, the marginal costs of commitments that limit discretion over abandonment can be determined and attributed to those commitments.