Optimal investment with time-varying transition probabilities for regime switching

Abstract>This study aims to generalize the following result of McDonald and Siegel (1986) on optimal investment: it is optimal for an investor to invest when project cash flows exceed a certain threshold. This study presents other results that refine or extend this one by integrating timing flexi...

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Bibliographic Details
Published in:Seonmul yeongu (Online) 2021-06, Vol.29 (2), p.102-115
Main Authors: Hyo-Chan, Lee, Park, Seyoung, Yoon, Jong Mun
Format: Article
Language:English
Subjects:
Bear markets
Brownian motion
Bull markets
cash flows
Derivatives
Discount rates
Flexibility
Investment policy
Investments
Macroeconomics
Markov analysis
optimal investment
option
Present value
Probability
regime switching
time-varying transition probabilities
Volatility
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Summary:Abstract>This study aims to generalize the following result of McDonald and Siegel (1986) on optimal investment: it is optimal for an investor to invest when project cash flows exceed a certain threshold. This study presents other results that refine or extend this one by integrating timing flexibility and changes in cash flows with time-varying transition probabilities for regime switching. This study emphasizes that optimal thresholds are either overvalued or undervalued in the absence of time-varying transition probabilities. Accordingly, the stochastic nature of transition probabilities has important implications to the search for optimal timing of investment.
ISSN:1229-988X
2713-6647
DOI:10.1108/JDQS-12-2020-0032