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CIO Springer TAP Compal BES FCT
TC4 Real options
Session organizer: Stein-Erik Fleten, Norwegian University of Science and Technology, Norway

Chair: Stein-Erik Fleten, Norwegian University of Science and Technology, Norway
Room 3.1.10


Technological Change: A Burden or a Chance

Verena Hagspiel (, Pedro Jesus (, Peter Kort (, Cláudia Nunes (
This paper considers a firm that faces a declining profit stream for its established product. The firm has the option to invest in a new technology with which it can produce an innovative product while having the option to exit as well as suspend operations at any point in time. Besides timing the firm also has to decide about the size of investment. Considering fixed capacity size, earlier work showed that higher uncertainty might accelerate investment timing. We show that introducing the capacity decision restores the standard result that higher uncertainty delays investment timing. Higher potential profitability of the innovative product market increases the incentive to invest earlier. However, we find that it does not affect the optimal investment size. Furthermore, we get the at first sight counterintuitive result that the firm invests in smaller capacity the larger the growth in the innovative product market. We also obtain that the effect of uncertainty on the exit threshold is non-monotonic when taking into account the capacity choice decision.

Keywords: Technological change, Investment analysis, Capacity choice


Investment in clean energy: a real options aproach

Cláudia Nunes (, Hugo Pinto (, Daniel Schwarz (
In this paper we analyze the problem of investment in clean energy, using a valuation model that takes into account the allowance prices as proposed by Carmona and Hinz (2011). The HJB equation associated to this problem involves a PDE with explicit time dependency, due to the digital nature of the terminal allowance price. For such a problem we propose a numerical method based on finite elements to find an approximate solution for the optimal investment decision. One of the major problem is related to the free boundary (in 2 dimensions). We use an argument based on a change-of-variable formula, as proposed by Peskir (2005). Some numerical results are presented, showing the effect of the parameters in the investment decision.

Keywords: Real options, Free boundary, Finite element method


Structural estimation of switching costs

Stein-Erik Fleten (, Erik Haugom (, Alois Pichler (, Carl J. Ullrich (
We develop a method to estimate irreversible switching costs associated with economic state changes. Necessary input include observations of state changes over several facilities and over time, and the time series of a profit indicator. The proposed method does not require unrealistic assumptions about the data generating process. Instead we use the state change observations directly, thereby eliminating the need to estimate parameters associated with a random process. The method extends recent contributions in structural estimation, combining nonparametric statistics with nonlinear programming. We implement the method on a unique dataset of U.S. power plants. In the wake of increased penetration of electricity generation from renewable sources into energy systems, regulators are particularly concerned about temporary and permanent shutdowns of conventional plants. Economically meaningful results obtain.

Keywords: Structural estimation, Real options, Electricity markets