1 option
Investment, Consumption, and Hedging under Incomplete Markets / Jianjun Miao, Neng Wang.
- Format:
- Book
- Author/Creator:
- Miao, Jianjun.
- Series:
- Working Paper Series (National Bureau of Economic Research) no. w13250.
- NBER working paper series no. w13250
- Language:
- English
- Physical Description:
- 1 online resource: illustrations (black and white);
- Place of Publication:
- Cambridge, Mass. National Bureau of Economic Research 2007.
- Summary:
- Entrepreneurs often face undiversifiable idiosyncratic risks from their business investments. We extend the standard real options approach to an incomplete markets environment and analyze the joint decisions of business investments, consumption/savings, and portfolio selection. For a lump-sum investment payoff and an agent with a sufficiently strong precautionary savings motive, an increase in volatility can accelerate investment, contrary to the standard real options analysis. When the agent can trade the market portfolio to partially hedge against investment risk, the systematic volatility is compensated via the standard CAPM argument, and the idiosyncratic volatility generates a private equity premium. Finally, when the investment payoff is a series of flows, the agent's idiosyncratic risk exposure alters both the implied option value and the implied project value, causing a reversal of the results in the lump-sum payoff case.
- Notes:
- Print version record
- July 2007.
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