A Real Option Model with Uncertain, Sequential Investment and with Time to Build

Abstract

This article develops a real option model with uncertain and sequential investment and with time to build. The model includes options to entry and to exit the activity and addresses the maximization problem of a company in view of the investment opportunity. The differential equation of the asset is obtained by using dynamic programming and risk neutral evaluation. Particularly, for the construction period, the differential equation is partial and elliptical, which demands the use of numeric methods. The main results of the article are that (i) with uncertain and sequential investment and with time to build, the waiting value, which creates a gap between the investment decision rule based on NPV and that based on a real option model, may not very significant and (ii) the increase in uncertainty may anticipate the decision to investment.

Keywords

• investment under uncertainty
• real options
• sequential investment
• tme to build
• elliptical partial differential equations
• numercial methods