Final published version
Research output: Contribution to Journal/Magazine › Journal article › peer-review
Research output: Contribution to Journal/Magazine › Journal article › peer-review
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TY - JOUR
T1 - Hysteresis effects under CIR interest rates
AU - Dias, José Carlos
AU - Shackleton, Mark B.
PY - 2011/6/16
Y1 - 2011/6/16
N2 - Most decision making research in real options focuses on revenue uncertainty assuming discount rates remain constant. However, for many decisions 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 in 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. However, for many decisions 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 in Dixit (1989a)). Under stochastic interest rates, economic hysteresis is found to be significant, even for small sunk costs.
KW - Finance
KW - Interest rate uncertainty
KW - Investment hysteresis
KW - Perpetuities
KW - Real options
U2 - 10.1016/j.ejor.2010.12.021
DO - 10.1016/j.ejor.2010.12.021
M3 - Journal article
AN - SCOPUS:79952193450
VL - 211
SP - 594
EP - 600
JO - European Journal of Operational Research
JF - European Journal of Operational Research
SN - 0377-2217
IS - 3
ER -