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Managerial Program 2016

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Past Papers


Annual International Conference on Real Options: Theory Meets Practice

Academic Program

Thursday July 25, 2013

[9:00 - 12:30 Tutorials (Extra)]

12:30 - 1:45 Registration & Luncheon

1:45 - 2:00 President's Welcome

2:00 - 3:40 Parallel Sessions

I. Empirical Evidence & Valuation Applications

Chairperson: Lenos Trigeorgis (U. of Cyprus)

Keeping the Lights On Until the Regulator Decides
Stein-Erik Fleten (Norwegian University of Science and Technology, Norway)
Erik Haugom (Norwegian University of Science and Technology/Lillehammer University College, Norway)
Carl Ullrich (Virginia Tech, United States)

The purpose of this paper is to examine empirically the real options to shutdown, startup, and abandon existing production assets using detailed information for 1,121 individual power plants for the period 2001–2009, a total of 8,189 plant-year observations. We find strong evidence of real options effects. We find that uncertainty about the outcome of ongoing deregulation in retail electricity markets (i) decreases the probability of shutting down operating plants, and, (ii) decreases the probability of starting up plants which were previously shutdown.

Online Selling Adoption Likelihood: Empirical Analysis of Main Drivers
Abdullah Almansour (King Fahd University of Petrroleum and Minirals (KFUPM), Saudi Arabia)
Abdullah Basiouni (Yanbu Industrial College, Royal Commission for Yanbu Project, Saudi Arabia)
Ahmad Alojairi (King Fahd University of Petrroleum and Minirals (KFUPM), Saudi Arabia)
Walid Bahamdan (King Fahd University of Petrroleum and Minirals (KFUPM), Saudi Arabia)

This paper uses a real options approach to empirically investigate the risk factors affecting the decision to adopt online selling. In particular, the paper studies the impact of these factors on the likelihood of a firm to adopt online selling. A unique data set gathered from Canadian firms and their industries has been exploited to examine this impact. The results show that stronger internal capabilities, higher competition and lower demand uncertainty increase the likelihood of a firm to adopt online selling.

Valuation of Wind Energy Projects
Luis M Abadie (Basque Centre for Climate Change, Spain)
Jose M Chamorro (University of the Basque Country, Spain)

We address the valuation of an operating wind farm and the finite-lived option to invest in it under different reward/support schemes. They range from a feed-in tariff to a premium on top of electricity market price, to a transitory subsidy. Availability of futures contracts on electricity with ever longer maturities allows to undertake market-based valuations. The model considers up to three sources of uncertainty, namely the future electricity price (which shows seasonality), the level of wind generation (which is intermittent in addition to seasonal), and the certificate (ROC) price. Lacking analytical solutions we resort to a trinomial lattice (which supports mean reversion in prices) combined with Monte Carlo simulation at each of the nodes in the lattice. Our data set refers to the UK. The numerical results show the impact of a number of factors involved in the decision to invest: the subsidy per MWh generated, the initial lump-sum subsidy, the investment option's maturity, and electricity price volatility. Different combinations of variables can help in bringing forward investments in wind generation. One-time policies, e.g. a transitory initial subsidy, seem to have a stronger effect than a premium per MWh produced.

Valuation of Strategic Options in Public-Private Partnerships
Gabriel Power (Laval University, Canada)
Mark Burris (Texas A&M University, United States)
Sharada Vadali (Texas A&M University, United States)
Dmitry Vedenov (Texas A&M University, United States)

We investigate a valuation model for buyout and other strategic options in Comprehensive Development Agreements (CDAs), public-private partnerships granting a private entity the right, through a lease, to price and collect revenues from toll roads for a finite period in exchange for providing local and state governments with cash and/or infrastructure. Uncertainty associated with such long-term leases is of substantial public concern. E.g., the government may believe it is not sufficiently compensated for the forfeited development opportunities or possible windfall profit during the lifetime of the lease. An under-studied aspect of the problem is the feasibility and economic value of an option for the government to buy back, conditionally or not, the leased infrastructure at a future date prior to lease expiration. Such an option would give the public sector additional control over the future use of leased facilities and address the above potential concerns. The buyout option valuation model developed in the paper could help transportation policymakers in decisions on leasing public infrastructure. The paper’s contributions include the analysis and feasibility assessment of buyout and revenue-sharing options, an economic consumer demand-based revenue model for purposes of simulation, and the numerical evaluation of the strategic options. The main conclusion is that buyout and revenue-sharing options tend to have a high cost relative to the value of the lease. It is therefore understandable that private sector developers are hesitant to allow such clauses to be included without significant compensation.

II. Best Student Paper Awards

Chairperson: Afzal Siddiqui (University College, London, UK)

Wind Generators and Market Power
Nihat MISIR (Copenhagen Business School, Denmark)

Electricity production from wind generators holds significant importance in European Union’s 20% renewable energy target by 2020. In this paper, I show that ownership of wind generators affects market outcomes by using both a Cournot oligopoly model and a real options model. In the Cournot oligopoly model, ownership of the wind generators by owners of fossil-fueled (peakload) generators, decreases total peakload production and increases the market price. These effects increase with total wind generation and aggregate wind generator ownership. In the real options model, start up and shut down price thresholds are significantly higher when the monopolist at the peakload level owns both types of generators. Furthermore, when producing electricity with the peakload generator, the monopolist can avoid facing prices below marginal cost by owning a certain share of the wind generators.

Sensitivity of Demand Function in a Strategic Real Options Context
Hendrika Jobina Boonman (Tilburg University, Netherlands)
Verena Hagspiel (University of Lausanne, Switzerland)

This paper studies the effect of the three most commonly used demand functions, i.e. additive, multiplicative and iso-elastic demand, on the investment decisions of two competitive firms. We show that the relative investment decision of the two firms can be very sensitive to the choice of a specific demand function. We find that the use of the multiplicative demand function results in a market where the leader has a bigger capacity than the follower. This is caused by the fixed price intercept of the multiplicative demand model, which implies that there is a fixed market size that has to be shared among the two firms in the market. Because the leader makes its investment decision first, it will be the firm with the largest capacity in the market. The opposite result occurs for the iso-elastic and additive demand model, because these models have no upper bound on demand. Then a follower will delay investment, in order to optimally invest in a large capacity amount. However, the introduction of convex costs violates the previous multiplicative result with linear costs. When the convex costs are sufficiently high, also for this demand function we find that the follower is the firm with the largest capacity. Furthermore, for the iso-elastic demand function, we show that only for a low elasticity parameter the monopoly profit of the leader is large enough that it is optimal to use the deterrence strategy.

Evaluating Mortgage Mitigation Options: A Simulation of Alternative US Mortgage Distress Termination Options
Michael Flanagan (Manchester Metropolitan University, United Kingdom)

We provide an appropriate comprehensive model for assessing the likely contribution of current US government programs to alleviate homeownership financial distress. In a simulation of six available mortgage distress termination options, including continuation and repayment, the HAMP program appears to foster mortgage mitigation, given our parameter value assumptions. However, conclusive policy appraisal awaits satisfactory empirical work. Our model might be extended to other areas of financial distress, including corporate finance and sovereign debt problems.

Do Managers Pay for the Growth Options in Buy-and-Build Acquisitions? An Empirical Analysis
Joris Kil (Erasmus University Rotterdam, Netherlands)

This paper considers premiums paid for initial intra-industry acquisitions part of a “buy- and-build” acquisition strategy for industry consolidation. We find that buy-and-build acquirers on average pay between 8 and 20% higher premiums for their first acquisition compared to acquirers that don’t follow such a strategy. The higher premium can be explained following real option theory in serial acquisitions where the first acquisition in a series serves as the prerequisite for future target appropriation and, considering the total future value of the acquisition series, can justify payment of a higher premium. Our empirical analysis suggests that the strategic idea of pursuing a buy-and-build strategy offers the best explanation for the difference in premiums paid compared to related non buy-and build acquisitions. The insignificant market reaction suggests there is no short term, ex-ante added shareholder value in this particular acquisition strategy.

4:00 - 4:45

Keynote Address

Thoughts on Real Options
Lenos Trigeorgis (University of Cyprus, Cyprus)

4:45 – 5:45  Managerial Panel Discussion
Real Options Application: Successes and Impediments
Moderator: D. Paxson (U. of Manchester, UK)

Panelists Include:
L. Brandao (PUC-Rio, Brazil)
Y. Kawaguchi (President, Real Estate Financial Engineering Society, Japan)
Y. Lawryshyn (U. Toronto, Canada)
G. Sick (U. Calgary, Canada)

5:45 – 7:15  Networking Reception

Sponsored by ROG, U. of Tokyo and JAROS

Friday July 26, 2013

8:30 - 9:00 Registration

2:00 - 3:40 Parallel Sessions

9:00 - 10:15

I. Energy Investments and Operational Flexibility

Chairperson: Stein-Erik Fleten (Norwegian U. of Science and Technology)

Subsidies for Renewable Energy under Uncertainty
Roger Adkins (Bradford University School of Management, United Kingdom)
Dean Paxson (Manchester Business School, United Kingdom)

We derive the optimal investment timing and real option value for a renewable energy facility with price and quantity uncertainty, where there might be a government subsidy proportion to the quantity of production. We consider permanent, or alternatively retractable, subsidies, and provide analytical solutions for different subsidy arrangements. Government policy uncertainty acts an incentive, or disincentive, depending on the arrangement.

Investment in Alternative Energy Technologies under Physical Plant and Policy Uncertainties
Afzal Siddiqui (University College London, United Kingdom)
Ryuta Takashima (Chiba Institute of Technology, Japan)

Policymakers have often backed alternative energy technologies, e.g., nuclear power, due to their relatively low operating costs and emissions. However, they have also been quick to respond to public perceptions about the safety of such plants by suspending construction or even decommissioning existing facilities. We address public concerns about physical plant risks along with stochastic market prices for energy by modelling investment in and decommissioning of alternative energy technologies.

Valuation of Operational Flexibilities in the Aluminum Industry
Carlos Bastian-Pinto (Ibmec Business School, Brazil)
Luiz Brandão (IAG Business School - Pontifícia Universidade Católica, Brazil)
Rafael Raphael (IAG Business School - Pontifícia Universidade Católica, Brazil)
Luiz Ozorio (Ibmec Business School, Brazil)

In the aluminum industry, which is subject to a significant volatility in its output prices, as well as in the cost associated with one of its main input costs, electricity, the possibility of reducing production costs through the flexibility of the production process can generate important value for such real options. We study the effect of the flexibility available to a typical smelter (aluminum processing plant), that buys its electricity through long term contracts or alternatively owns a co-generation unit, of stopping production and selling its electricity in the spot market, when the price of its output, aluminum, generates negative or unrewarding cash flows, or when the spot price of electricity is high enough to give a higher cash flow than from its normal production process. Nevertheless stopping, and more specifically, restarting production involves costs associated with refurbishing the smelters units thermal revetment that may hamper the value of such stoppage options. This paper values such options through Monte Carlo simulation, modeling the prices of aluminum as a geometric mean reversion, and the price of electricity as a mean reversion with positive jumps. It also incorporates the asymmetrical costs of stopping and restarting production and checks its influence in the value of the option associated.

9:00 - 10:15

II. Stochastic ROV Models

Chairperson: Gordon Sick (U. of Calgary, Canada)

Choice of Stochastic Process in ROV: Selecting Multiple Factor Models
Luiz Ozorio (Ibmec Business School, Brazil)
Pavel Schevchenko (CSIRO - Mathematic, Informatics and Statistics, Australia)
Carlos Bastian-Pinto (Ibmec Business School, Brazil)

The stochastic process choice plays a central role in real option valuation and it can have an impact not only on the project value but also on the investment rule. The first works written on real options used one factor models – more specifically Geometric Brownian Motion (GBM) and Mean Reversion Models(MRM) – to represent the uncertainties in the valuation modeling. Selecting the most appropriate model is not always a trivial issue, and besides statistical tools, in general, theoretical considerations are taken for this task. In order to generate more realistic models, in the last decades many authors have presented papers proposing the combination of different kinds of stochastic processes creating multiple factor models. Although these models can be more realistic, the task of selecting among many multiple factor models is even harder than in case of one factor models, which implies a new set of tools to make the analysis. This work discusses the choice of multiple factor models in real options valuation, and the main statistical tools and theoretical considerations that can be used for this task.

Exercise of Real Development Options and Corporate Risk Measures
Yuanshun Li (Ryerson University, Canada)
Gordon Sick (University of Calgary, Canada)

This paper investigates how the exercise of a real development option affects measures of corporate risk, such as volatility and beta. Various empirical studies examine the changes in risk measures and the cost of capital around the time of corporate investment (exercise of a real option), but they generally fail to separate the exercise of the real option from the financing effects associated with the investment. This means that they predictably get mixed results as they investigate changes in volatility, beta and cost of capital around the time of corporate investment.

Numerical Algorithms for R&D Stochastic Control Models
Chi Man Leung (City University of Hong Kong, Hong Kong)
Yue Kuen Kwok (Hong Kong University of Science and Technology, Hong Kong)

We consider the optimal strategy of R&D expenditure adopted by a firm that engages in R&D to develop an innovative product to be launched in the market. The firm faces with technological uncertainty associated with the success of the R&D effort and market uncertainty of the stochastic revenue flow generated by the new product. Our model departs from most R&D models by assuming that the firm’s knowledge accumulation has impact on the R&D progress, so the hazard rate of arrival of R&D success is no longer memoryless. Also, we assume a finite life span of the technologies that the product resides on. In this paper, we propose efficient finite difference schemes that solve the Hamilton-Jacobi-Bellman formulation of the resulting finite time R&D stochastic control models with an optimal control on R&D expenditure and an optimal stopping rule on the abandonment of R&D effort. The optimal strategies of R&D expenditure with varying sets of model parameters are analyzed. In particular, we observe that R&D expenditure decreases with firm’s knowledge stock and may even drop to zero when the accumulation level is sufficiently high.

10:45 - 12:00

I. R&D/Technology Options

Chairperson: Dean Paxson (U. Manchester, UK)

Patent Strategies: Fight or Cooperate?
Lenos Trigeorgis (Department of Accounting and Finance, University of Cyprus, Cyprus)
Francesco Baldi (Department of Business and Management, Italy)

We consider a dynamic notion of strategy involving a menu of patent leveraging strategies enabling the firm to switch among compete (fight), cooperate or wait (patent sleep) modes under different demand or volatility regimes. We address the optimality of different competitive strategies based on demand and patent advantage, examining the circumstances under which strategic patenting is best used in a fight, such as building a patent wall or bracketing the rival’s patent, or in a cooperative mode, such as licensing out or cross-licensing patents. Hybrid strategies may obtain, involving switching from one type of fight mode to another or from competition to cooperation as demand rises or as the patent advantage gets small. Higher demand is most peculiar as initially give-up strategies may switch to fighting and then, at higher demand levels, to cooperation. Dynamic patent switch strategy is more valuable in a more volatile market and competitive environment.

Technological Change: A Burden or an Opportunity?
Verena Hagspiel (University of Lausanne, Switzerland)
Peter Kort (Tilburg University, Netherlands)
Claudia Nunes (Instituto Superior Tecnico, Portugal)

In this paper we study the problem of a firm that produces with a current technology for which it faces a declining sales volume. It has two options: it can either exit this industry or invest in a new technology with which it can produce an innovative product. We distinguish between two scenarios in the sense that the resulting new market can be booming or ends up to be smaller than the old market used to be. We derive the optimal strategy of a firm for each scenario and specify the probabilities with which a firm would decide to innovate or to exit. Furthermore, we assume that the firm can additionally choose to suspend production for some time in case demand is too low, instead of immediately taking the irreversible decision to exit the market. We derive conditions under which such an suspension area exists and show how long a firm is expected to remain in this suspension area before resuming production, investing in new technology or exiting the market.

R&D Competition Among Asymmetric Firms with Spillovers
Chi Man Leung (City University of Hong Kong, Hong Kong)
Yue Kuen Kwok (Hong Kong University of Science and Technology, Hong Kong)

Using real options game models, we consider the characterization of strategic equilibria associated with an asymmetric R&D race between an incumbent firm and an entrant firm in the development of a new substitute product under market and technological uncertainties. The random arrival time of the discovery of the patent protected innovative product is modeled as a Poisson process. Input spillovers on the R&D effort are modeled by the change in the leader’s hazard rate of success of innovation upon the follower’s entry into the R&D race. Under asymmetric duopoly, we obtain the complete characterization of the three types of Markov perfect equilibria (sequential leader-follower, preemption and simultaneous entry) of the firms’ optimal R&D entry decisions. Our model shows that under positive externalities where the input spillover is positive, preemptive equilibrium is always ruled out in the R&D race due to the presence of dominant second mover advantage. The two firms choose optimally to enter simultaneously if the sunk cost asymmetry is relatively small; otherwise, the occurrence of sequential equilibrium is resulted. The condition where the initial hazard rate is low relative to the level of input spillover would lead to the optimal choice of simultaneous entry and signifies another scenario of dominant second mover advantage. However, when the initial hazard rate is sufficiently high so that the first mover advantage becomes more significant, simultaneous equilibrium is ruled out even under high level of positive input spillover.

10:45 - 12:00

II. Sequential Investment

Chairperson: Ryuta Takashima (Chiba Institute of Technology, Japan)

Analysis of Sequential Investment Opportunities
Roger Adkins (Bradford University School of Management, United Kingdom)
Dean Paxson (Manchester Business School, United Kingdom)

We provide an analytical solution for perpetual American compound real options, applicable for a real sequential investment opportunity. We show the value thresholds, and the ROV at each of the stages, when there is the possibility of total failure of the project at various stages. Results are often surprising, with sometimes negative vegas. Uncertainty with failure possibilities does not always increase real option value.

Sequential Investment, Capacity Size and Optimal Staging Flexibility
Kimitoshi Sato (Waseda University, Japan)
Yuta Naito (Mitsubishi UFJ Morgan Stanley Securities Co., Ltd., Japan)
Ryuta Takashima (Chiba Institute of Technology, Japan)

We consider the problem of a typical investor who has discretion over not only the timing, but also the sizing of a new plant in sequential manner. We contrast the sequential investment strategies for different stage numbers in order to the value of flexibility. Additionally, we analyze the sequential investment for a case in which there exists a fixed cost in the investment one. The optimal stage numbers of sequential investment are obtained for various fixed costs.

Rolling or Fixed Exercise Dates for Compound American Options: A Numerical Analysis
Carlos Deck (Universidad de los Andes, Chile)

Due to the complexities of solving PDEs, a general assumption regarding real options is to discard time-dependency. Nevertheless, this assumption is not necessarily realistic, considering that people tend to simplify problems by self imposing maturity dates. To study this phenomenon, the value of a compounded American option is compared considering two different exercise rules, using either (1) fixed dates under which a decision must be made, or (2) establishing a fixed lead time after an option exercise where an investor cannot exercise its claim over the asset. These values are then computed using numerical methods, in order to calculate under which circumstances it is worthwhile to establish limited timeframes to maximize a project’s value.

2:00 - 3:15

I.  Mergers, Acquisitions & Abandonment

Chairperson: Luiz Brandão (PUC Rio, Brazil)

M&A Target Portfolio Selection
Jani Kinnunen (IAMSR, Åbo Akademi University, Finland)
Irina Georgescu (Academy of Economic Studies, Department of Economic Cybernetics, Romania)

In this paper we present a two-component portfolio selection problem under two types of uncertainties, i.e., probabilistic risk and possibilistic risk. We study the portfolio selection problem in mergers and acquisitions, M&As, and show the usability of the presented mixed model in portfolio selection of corporate acquisition targets. We view the total M&A value consisting of a stand-alone of a target value plus a synergistic strategic (real options) value. We illustrate, through a numerical example, how the portfolio model can be applied to M&As from an acquirer’s perspective, in the case, where some targets are valued probabilistically using Datar-Mathews real options approach (Datar and Mathews, 2004) to value the strategic part and other targets possibilistically using the fuzzy real options approach to value the strategic part as presented by Kinnunen (2010) in the 14th Annual International Conference on Real Options and the Japan Association of 
Real Options and Strategy’s journal paper of Collan and Kinnunen (2011). The portfolio problem corresponds to a situation in which some return rates on M&A investments are described by random variables, while others by fuzzy numbers. We discuss the setup of an acquirer facing a situation in which some acquisition targets are reasonable to be valued probabilistically and others possibilistically. Markowitz probabilistic model and a possibilistic portfolio selection model are unified resulting in the optimal solution of the mixed portfolio problem with the minimum of the unified portfolio risk.

Optimal Timing of Announcement in Merger and Acquisition Activity
Jinghui Dong (Toyo University, Japan)
Yoshio Iihara (Japan)

This paper considers the optimal timing of announcement in merger and acquisition activity. The optimal timing is determined to maximize the expected present value of the difference between the acquirer's increased firm value after merger and the purchasing cost of the target firm. The acquirer's increased firm value varies under influence of movements in economic situations, political environments, and firms' individual circumstances. Because of the complexity and cost of estimating the increased firm value, operations of reassessing may be difficult to carry out constantly. In this paper, we consider the situation that the events which cause reassessing of increased firm value occur discretely, therefore, the acquirer's increased firm value changes discretely. Assume that occurrence of changes in the increased firm value follows Poisson processes, and the size of changes are also uncertain, its logarithm has exponential distributions. The purchase cost changes based on the stock price of the target firm which is assumed following a geometric Brownian motion. Using real option approach, a closed form solution of the optimal timing is obtained. We also show comparative static results and some numerical examples.

Extended MAD for Real Option Valuation: Case Study of Abandonment

Carol Alexander (School of Business, Management and Economics, University of Sussex, United Kingdom)
Xi Chen (ICMA Centre, Henley Business School, University of Reading, United Kingdom)
Charles Ward (ICMA Centre, Henley Business School, University of Reading, United Kingdom)

This paper extends the marketed asset disclaimer approach for real option valuation. In sharp contrast to the dominant real option valuation that assumes a stochastic process for an investment's capital value, this paper demonstrates the valuation of a real option assuming that cash flow follows a stochastic process. We show that this method is at least equally effective and sometimes more intuitive. We note that, in a discounted cash flow (DCF) framework, certain constraints must be met, and assuming capital value as a geometric Brownian motion (GBM) is compatible with simultaneously assuming cash flow as a GBM, We clarify the above argument with a simple textbook-standard case study.

2:00 - 3:15

II. IO & Games Applications

Chairperson: Kunno Huisman (Tilburg U., Netherlands)

Investment Decisions in Finite-lived Monopolies
Paulo J. Pereira (CEF.UP and School of Economics and Management, University of Porto, Portugal)
Artur Rodrigues (NIPE and School of Economics and Management, University of Minho, Portugal)

This paper studies the value and optimal timing for investment in a finite-lived monopoly. We extend the literature on option games by considering the cases of random and certain-lived monopolies. When compared to the duopoly and monopoly market structures, these new settings produce significantly different results. A certain- lived monopoly induces investment sooner than the duopoly, if the initial firm in the market faces the risk of being preempted and, on the contrary, can deter invest- ment more than in monopoly case if the leader role is pre-assigned. A random-lived monopoly induces entry somewhere between the duopoly and monopoly cases. A higher uncertainty deters investment in all cases.

Vertical Governance Change for Product Differentiation under Decreasing Component Costs
Ben Vermeulen (University of Hohenheim, Germany)
Kuno Huisman (Tilburg University, Netherlands)
AG (Ton) de Kok (Eindhoven University of Technology, Netherlands)

We study the real option theoretic solution to vertical governance change in Bertrand duopoly competition under mean-reverting commodity component costs. We find that, even if component costs are low and decreasing, incurring high in-house component costs is warranted to decrease product substitutability and thereby soften price competition. As the competitor enjoys softened competition but does not bear higher component costs, firms may wait for competitors to move or the industry may feature a mix in governance forms. In case both firms are integrated, vertical specialization by one increases substitutability for both, such that the competitor is likely to follow.

Corporate Financing and Investment Expansion under Asymmetric Information
Junichi Imai (Keio University, Japan)
Ryoya Maruyama (Keio University, Japan)

This paper develops a dynamic model that takes the optimal timing of investment into consideration. This investment cost is concurrently financed at the investment time from an equity market. We introduce two firms that have similar investment projects but different expansion rates, assuming that a good firm with a higher expansion rate can capture more favorable investment opportunities than a bad firm with a lower expansion rate. Each firm makes the optimal exercise decision to expand under competitive environment. We also examine information asymmetry, that is, both firms know the expansion rates while equity investors cannot observe the difference between the two firms. In the paper we derive the equilibrium strategies for both firms under competitive environment and information asymmetry. We mainly show that: the bad firm has an incentive to mimic the good firm due to the presence of the information asymmetry. In response, the good firm is forced to invest earlier than the optimal timing for the good firm under the symmetric information to be recognized as the good firm from the equity market. The signal is observed by the investors and the good firm can finance at a lower cost. Consequently, separating equilibrium is established under the dynamic investment model. This result is different from that obtained by a static model. We derive different types of equilibrium strategy in numerical experiments. We also perform the sensitivity analysis and examine the effect of parameter values in the model.

3:45 - 5:00

I. Environmental Investment & Policy

Chairperson: Motoh Tsujimura (Doshisha U., Japan)

Optimal Policy for Attracting FDI: Investment Cost subsidies vs. Tax Rate Reduction
Masaaki Kijima (Tokyo Metropolitan University, Japan)
Yuan Tian (Ryukoku University, Japan)

This paper examines and compares two policies for a host government to attract FDI: investment cost subsidy and tax rate reduction. While investment cost subsidy is provided by the host government at the time that a foreign firm initiates FDI, tax rate reduction is applied to the instantaneous profit earned by the foreign firm after investment. We demonstrate that the optimal policy for attracting FDI depends on the profit uncertainty. There exists a critical level of the profit uncertainty: when the uncertainty is smaller than the critical level, investment cost subsidy is optimal; when the uncertainty is larger than the critical level, tax rate reduction is optimal.

Supporting Low Carbon Policies under Fuel and Renewable Sources Development Uncertainties
Hiroshi Takamori (Waseda University, Japan)
Tak Niimura (Hosei University, Japan)
Daiki Yamashita (Waseda University, Japan)
Ti Wang (Waseda University, Japan)
Ryuichi Yokoyama (Waseda University, Japan)

This paper explores two avenues for nurturing a new energy-saving sector under uncertain prospect of the carbon economy as well as renewable energy sources development. The first part addresses a hand-in-hand development of lug-in electric vehicle (PEV) markets and the charging Infrastructure for PEV users. We introduce a model that would help the policy maker on how to allocate subsidy funds between giving price incentives to consumer and subsidizing the infrastructure business investment. The second part addresses designing a smart-grid scheme that would make crowds of EV users the part of the energy management optimizers of a smart community. A collected mass of electrical vehicles provides the capacity as cushions for absorbing erratic energy disturbances caused byrenewable sources. The main instrument is to exercise the dynamic pricing and induce various types of users, including EV users, to respond to the electricity price driven their own incentives. Both approaches are motivated by the maxim of drawing on the dynamism of competitive market mechanisms.

Controls for Emission and Stock Abatement Policies
Motoh Tsujimura (Doshisha University, Japan)
Akira Maeda (The University of Tokyo, Japan)

This paper investigates emission and stock abatement policy decisions by the use of a stochastic optimal control model with a continuous-time setting. Environmental policies are typically referred as emission flow abatement (reduction) activities and thus, can be formulated as classical optimal control problems. However, because of recent shifts in the focus of policy measures, it is getting recognized that direct control of stock variables is also possible. To formulate such direct stock control in the framework of stochastic optimal control theory, an advanced form of control, called impulse control, is necessary. The purpose of the paper is to develop a model that combines classical flow control and impulse control, and to examine its mathematical features to obtain some policy implications.

3:45 - 5:00

II. Modeling/Computational

Chairperson: Yuri Lawryshyn (U. Toronto, Canada)

Determinants of the Value of Transferable Land Development Rights
Jyh-Bang Jou (National Taiwan University, Taiwan)
Tan Lee (University of Auckland, New Zealand)

This paper investigates the determinants of the value of transferable development rights (TDRs) when two landowners whose parcels of land are subject to a uniform density ceiling control. The control is binding to the landowner whose land near the central business district (CBD), but is not binding to the landowner whose land farther away from the CBD. The former is thus willing to purchase TDRs from the latter. The Nash bargaining solution between these two developers indicate that the value of TDRs per unit of density is larger when the latter supplies less redundant density allowance, the latter has a relative high bargaining power, and the demand for urban land fluctuates more severely.

Valuing Real Options Using Managerial Cash-Flow Estimates
Yuri Lawryshyn (University of Toronto, Canada)

In this work, we build on a previous real options approach that utilizes managerial cash-flow estimates to value early stage project investments. Through a simplifying assumption, where we assume that the managerial cash-flow estimates are normally distributed, we derive a closed-form solution to the real option problem. The model is developed through the introduction of a market sector indicator, which is assumed to be correlated to a tradeable market index, which drives the project's sales estimates. Another indicator, assumed partially correlated to the sales indicator drives the gross margin percent estimates. In this way we can model a cash-flow process that is partially correlated to a traded market index. This provides the mechanism for valuing real options of the cash-flow in a financially consistent manner under the risk-neutral minimum martingale measure. The method requires minimal subjective input of model parameters and is very easy to implement. We also investigate the sensitivity of the normal distribution assumption by comparing the approach developed here to our previous approach.

A General Decision-Tree Approach to Real Option Valuation
Carol Alexander (School of Business, Management and Economics, University of Sussex, United Kingdom)
Xi Chen (ICMA Centre, Henley Business School, University of Reading, United Kingdom)

The common paradigm for risk-neutral real-option pricing is a special case encompassed within our general model for valuing investment opportunities. Risk-neutral real option prices deviate from the risk-averse real option values that apply in an incomplete market, giving different rankings of investment opportunities and different optimal exercise strategies. Unlike risk-neutral prices, more general real option values often decrease with the volatility of the asset price. They also depend on the structure of fixed and variable investment costs, the expected return of the underlying asset, the frequency of decision opportunities, the price of the asset relative to initial wealth, the investor’s risk tolerance and its sensitivity to wealth. We explain how these factors affect the ranking of real option values under a standard geometric Brownian motion for the asset price. Numerical examples also consider ‘boom-bust’ or mean-reverting price scenarios and investments with positive or negative cash flows.

Real Options and Impulse Control with Outside Jumps
Makoto Goto (Hokkaido University/UC Berkeley, Japan)

In this paper, we study the impulse control problem with oudside jumps. As represented by (s,S) policies, imuplse control problems usually have inside jumps. Namely, when the inventory level goes down and hits a threshold, it jumps up by the order placement. However, in terms of capacity choice problems, firms should install additional capacities when the demand is increasing. That is, the impulse control problem we consider has outside jumps, which is hard to solve through usual approaches as reported in Goto, Takashima and Tsujimura (2006). Our approach is inspired by Guo and Tomecek (2008) who study connections between singular control and optimal switching problems.

5:15 – 6:00 Academic Panel Discussion: Current State, Challenges and Future Prospects

Moderator: G. Sick (U. of Calgary, Canada)

Panelists Include:
L. Brandão (PUC-Rio, Brazil)
S.-E. Fleten (Norwegian U. of Science and Technology, Norway)
K. Huisman (Tilburg U., Netherlands)
D. Paxson (U. of Manchester, UK)
A. Siddiqui (UCL, UK)
M. Tsujimura (Doshisha U., Japan)     

6:00 Closing Remarks/ Conference Concludes


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