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Research output: Working paper
Research output: Working paper
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TY - UNPB
T1 - Investment hysteresis under stochastic interest rates
AU - Dias, J C
AU - Shackleton, M B
PY - 2005
Y1 - 2005
N2 - Most decision making research in real options focuses on revenue uncertainty assuming discount rates remain constant. For many decisions, however, revenue or cost streams are relatively static and investment is driven by interest rate uncertainty, for example the decision to invest in durable machinery and equipment. Using interest rate models from Cox et al. (1985b), we generalize the work of Ingersoll and Ross (1992) in two ways. Firstly, we include real options on perpetuities (in addition to "zero coupon" cash flows). Secondly, we incorporate abandonment or disinvestment as well as investment options and thus model interest rate hysteresis [parallel to revenue uncertainty, Dixit (1989a)]. Under stochastic interest rates, economic hysteresis is found to be significant, even for small sunk costs.
AB - Most decision making research in real options focuses on revenue uncertainty assuming discount rates remain constant. For many decisions, however, revenue or cost streams are relatively static and investment is driven by interest rate uncertainty, for example the decision to invest in durable machinery and equipment. Using interest rate models from Cox et al. (1985b), we generalize the work of Ingersoll and Ross (1992) in two ways. Firstly, we include real options on perpetuities (in addition to "zero coupon" cash flows). Secondly, we incorporate abandonment or disinvestment as well as investment options and thus model interest rate hysteresis [parallel to revenue uncertainty, Dixit (1989a)]. Under stochastic interest rates, economic hysteresis is found to be significant, even for small sunk costs.
KW - real options
KW - interest rate uncertainty
KW - perpetuities
KW - investment hysteresis
M3 - Working paper
T3 - Accounting and Finance Working Paper Series
BT - Investment hysteresis under stochastic interest rates
PB - The Department of Accounting and Finance
CY - Lancaster University
ER -