The effect of mean reversion on investment under uncertainty

The Worst Case for Real Options

“…As argued in [13] and [14], this seems to be more realistic in today's knowledge economy with its fast-changing technology environment. Our analysis however applies to a wider class of problems, including maintenance studies as well.…”

Towards a Well-Founded Valuation of Managerial Flexibilities in IT Investment Projects - A Multidisciplinary Literature Review

“…This suggests that a higher supply always leads to a reduction in price and thus a reduction in dcif. The impact of GMR on the value of a perpetual American option is also considered by Sarkar (2003) who states that because of the lower and more stable long-run variance 15 , there is a significant (mostly negative) impact, with the result that it is generally inappropriate to use GBM instead of GMR. In the context of long-run European options the impact of GMR on the option value is even stronger, with the result that the reduced variance of GMR significantly reduces the real option value.…”

“…Other applications of Mean Reversion for dcif are developed for projects such as shipping (Bjerksund and Ekern 1995) or start-up venture financing (Willner 1995), and are presented in Trigeorgis (1995). Another alternative to GBM is implemented by Ewald and Wang (2007) who argue that GMR, as used by Dixit and Pindyck (1994), Metcalf and Hasset (1995), and Sarkar (2003), has the property of its Mean Reversion speed being proportional to the level of dcif (i.e., the higher the value of dcif, the higher is the Mean Reversion speed). However, while this seems to be economically questionable, it can be compensated through the use of the slightly different Cox-IngersollRoss Mean Reversion model 16 (Cox et al 1985), and is one of the most prominent processes used to model interest and exchange rates.…”

“…They state that, depending on the many parameters, no clear implication on the option value in relation to the standard case of certain dcof can be given. Brennan and Schwartz (1985); Dixit and Pindyk (1994)*; Myers and Majd (1990);Tourinho (1979) Articles where the BSM is used, for example : Benaroch and Kauffman (1999); Benaroch et al (2006); Heinrich et al (2011);Klaus et al (2014); Su et al (2009);Taudes (1998) Uncertain Incomplete Market Certain Childs et al (2001);Guthrie (2007); Henderson (2004;; Hugonnier and Morellec (2007); Merton (1998) Balasubramanian et al (2000; Benaroch and Kauffman (2000); Diepold et al (2011);Hilhorst et al (2006) Dias and Nunes (2011);Dixit and Pindyk (1994); Epstein et al (1998); Ewald and Wang (2007); Metcalf and Hassett (1995);Sarkar (2003); Schwartz (1997) To sum up, in the IS literature we identified some approaches, which modify single assumptions of the BSM and comply with our relaxed assumptions. The same holds for the Finance and Economics literature where we further identified a few approaches that are based on two modified assumptions that comply with our relaxed assumptions.…”

Decision Support for IT Investment Projects

“…Incomplete market Deterministic Certain Balasubramanian et al (2000), Benaroch and Kauffman (2000), Childs et al (2001), Diepold et al (2011), Guthrie (2007, Henderson (2004;, Hilhorst et al (2006), Hugonnier and Morellec (2007) and Merton (1998) Dixit and Pindyck (1994), Epstein et al (1998), Ewald and Wang (2010), Metcalf and Hassett (1995), Sarkar (2003), Schwartz (1997) and Schwartz and Smith (2000) Bardhan et al 2004;Benaroch and Kauffman 1999;Kauffman and Kumar 2008;Ji 2010;Schwartz and Zozaya-Gorostiza 2003), who take DCOF to be uncertain. This raises the question of how DCOF are distributed.…”