How to design down-and-out barrier option contracts so that firms invest when it is socially efficient

Jyh Bang Jou, Tan (Charlene) Lee

Research output: Contribution to journalArticlepeer-review

Abstract

This paper investigates how to design down-and-out barrier options contracts so as firms invest when it is socially efficient. A government initially offers a firm a privileged right to exercise an investment opportunity that exhibits external benefits to society, but will eliminate this opportunity if its prospects are sufficiently bleak. The firm will invest at the date further away from that is socially efficient if the firm either is less uncertain about the return of the investment or incurs lower investment costs, or the government owns a more valuable knock-out option. Consequently, under these three scenarios the government can efficiently either offer the firm a higher investment tax credit or impose the firm a higher lease fee for holding the option to invest.

Original languageEnglish
Pages (from-to)1561-1579
Number of pages19
JournalEuropean Journal of Finance
Volume22
Issue number15
DOIs
StatePublished - 7 Dec 2016

Keywords

  • American options
  • down-and-out options
  • investment tax credits
  • irreversible investment
  • socially efficient

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