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Missed Opportunities: Optimal Investment Timing When Information is Costly

Published online by Cambridge University Press:  06 April 2009

Graeme Guthrie
Graeme Guthrie
Affiliation:
[email protected], School of Economics and Finance, PO Box 600, Victoria University of Wellington, Wellington, New Zealand.
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Abstract

Real option analysis typically assumes that projects are continuously evaluated and launched at precisely the time determined to be optimal, but real world projects cannot be managed in this way because of the costs of formally evaluating an investment opportunity. This paper shows that immediate investment is more attractive if evaluation costs are high or the amount of information to be revealed by an evaluation is large. The optimal delay until a reevaluation is long if evaluation costs are high or the amount of information to be revealed by an evaluation is small. The reduction in the value of project rights is especially severe when the value of the completed project is strongly mean reverting because then precision in investment timing is particularly important.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 42 , Issue 2 , June 2007 , pp. 467 - 488
Copyright
Copyright © School of Business Administration, University of Washington 2007

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