Financial Hedging of Operational Flexibility
نویسنده
چکیده
We extend the framework of real options to value the compound timing option owned by a manager of an industrial asset. The operator has control over the production modes, but faces operational constraints which introduce path-dependency. Moreover, the operator is only able to imperfectly hedge her income on the futures market. Using an exponential indifference valuation approach we construct a combined stochastic control formulation that merges the problems of optimal switching and indifference pricing in incomplete markets. We then present an iterative scheme for valuing operational flexibility which in particular shows additivity of indifference value over time. After discussing details of numerical implementation, we illustrate our results with several numerical examples and comparative statics. JEL code: D81, C61, G13 MSC 2000 code: 90B50, 93E20, 91B28, 60G40 Date: First Version: May 2006. This version: October 16, 2007. I thank Patrick Cheridito, Vicky Henderson, Dmitry Kramkov, Sasha Stoikov and seminar participants at University of Florida for useful discussions.
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