Real option model of dynamic growth processes with consumption

Nengsheng Fang, Xinfeng Ruan, Caixiu Liao*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

Abstract

A real option model is built upon a set of stochastic processes for some real investment decision making in incomplete markets. Typically, the optimal consumption level is obtained under a logarithmic utility constraint, and a partial integro-differential equation (PIDE) of the real option is deduced by martingale methods. Analytical formulation of the PIDE is solved by Fourier transformation. Two types of decision making strategies, i.e. option price and IRP (inner risk primium) comparisons, are provided. Finally, the Monte Carlo simulation and numerical computation are illustrated to verify the conclusions.

Original languageEnglish
Pages (from-to)2223-2239
Number of pages17
JournalCommunications in Mathematical Sciences
Volume13
Issue number8
DOIs
Publication statusPublished - 2015
Externally publishedYes

Keywords

  • Asset pricing
  • Jump diffusion
  • Optimal consumption strategy
  • Real option
  • Risk premium

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