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A Bayesian Approach to Real Options: The Case of Distinguishing between Temporary and Permanent Shocks

Year: 2010

Type: article

Abstract: ABSTRACT Traditional real options models demonstrate the importance of the “option to wait” due to uncertainty over future shocks to project cash flows. However, there is often another important source of uncertainty: uncertainty over the permanence of past shocks. Adding Bayesian uncertainty over the permanence of past shocks augments the traditional option to wait with an additional “option to learn.” The implied investment behavior differs significantly from that in standard models. For example, investment may occur at a time of stable or decreasing cash flows, respond sluggishly to cash flow shocks, and depend on the timing of project cash flows.

Source: The Journal of Finance

DOI: 10.1111/j.1540-6261.2010.01599.x

Authors: STEVEN R. GRENADIER, ANDREY MALENKO

Institutions: Stanford University, University of Michigan, Centre for Economic Policy Research

Language: English

Topic: Capital Investment and Risk Analysis

Subfield: Finance

Field: Economics, Econometrics and Finance

Domain: Social Sciences

Open Access status: green

OpenAlex ID: W2124454808

FWCI: 2.786

Cites: 40

Cited by: 69

Related to: 10