Management Science Vol. 61 No. 5 2015

Real Options and American Derivatives: The Double Continuation Region

Anna Battauz¹; Marzia De Donno²; Alessandro Sbuelz³

¹ Department of Finance and Innocenzo Gasparini Institute for Economic Research, Bocconi University, 20136 Milan, Italy · ² Department of Economics, University of Parma, 43125 Parma, Italy · ³ Department of Econometrics and Mathematics for Economic, Financial and Actuarial Applications, Catholic University of Milan, 20123 Milan, Italy

Abstract

We study the nonstandard optimal exercise policy associated with relevant capital investment options and with the prepayment option of widespread collateralized-borrowing contracts like the gold loan. Option exercise is optimally postponed not only when moneyness is insufficient, but also when it is excessive. We extend the classical optimal exercise properties for American options. Early exercise of an American call with a negative underlying payout rate can occur if the option is moderately in the money. We fully characterize the existence, the monotonicity, the continuity, the limits, and the asymptotic behavior at maturity of the double free boundary that separates the exercise region from the double continuation region. We find that the finite-maturity nonstandard policy conspicuously differs from the infinite-maturity one.

DOI

10.1287/mnsc.2013.1891

Volume

61

Issue

5

Pages

1094-1107

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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