| dc.description.abstract | This thesis investigates optimal investment in real options with the presence of regime
switching and mean reverting commodity prices. Our aim is to provide a methodology
that can address such behaviors in a commodity. Therefore, we are studying the electricity
spot price as the underlying asset. In order to discover the value of the investment
opportunity, we applied a combination of methods by utilizing a detailed algorithm. The
algorithm accounts for early exercise values and is thus intended to value American real
options. The analysis utilizes electricity price as the underlying variable on an investment
in a hydropower plant. We find that electricity prices follow a mean reverting process with
regime dependent parameters. Given this stochastic process, we analyze the optimal timing
of an investment decision using a regime-augmented binomial tree.
We illustrated the use of the algorithm on the hypothetical investment opportunity, where
it provides us with the option value tree for the two volatility states as well as the optimal
early exercise boundaries within each state. Our findings show that the algorithm is an
efficient and easy way to value American real options with a mean-reverting underlying
variable with multiple volatility states. It gives a fair option value and supplies early exercise
boundaries for the option. The algorithm can easily be applied to time series with
different characteristics and behaviours as well, with minor changes. | en_US |
