Authors
John Driffill, Turalay Kenc, Martin Sola
Publication date
2013/8/27
Journal
International Journal of Theoretical and Applied Finance
Volume
16
Issue
05
Pages
1350028
Publisher
World Scientific Publishing Company
Description
We develop a model of regime-switching risk premia as well as regime-dependent factor risk premia to price real options. The model incorporates the observation that the underlying risky income streams of real options are subject to discrete shifts over time as well as random changes. The presence of discrete shifts is due to systematic and unsystematic risk associated with changes in business cycles or in economic policy regimes or events such as takeovers, major changes in business plans. We analyze the impact of regime-switching behavior on the valuation of projects and investment opportunities. We find that accounting for Markov switching risk results in a delay in the expected timing of the investment while the regime-specific factor risk premia make the possibility of a regime shift more pronounced.
Total citations
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Scholar articles
J Driffill, T Kenc, M Sola - International Journal of Theoretical and Applied …, 2013