Fluctuating uncertainty and flexibility value

Research output: Contribution to journalArticle

2 Citations (Scopus)

Abstract

A simple model of recurrent fluctuating uncertainty with two types of investment assets, commitment and flexible, where fluctuating uncertainty is defined as changes between high and low confidence regimes, is constructed. By assuming risk neutrality, I find analytically a formula for flexibility value that is defined as the difference between the expected return to the commitment asset and the expected return to the flexible asset. This flexibility value is positive in the low confidence regime because of a positive attribute of the flexibility asset that is the option to utilize new information later. The relation between flexibility value and other parameters of the model is also considered. Flexibility value increases as the information an individual obtains in the high confidence regime increases or the discounting factor of the individual increases. Finally, flexibility value can increase even if, ceteris paribus, the return to the commitment asset increases.

Original languageEnglish
Pages (from-to)329-340
Number of pages12
JournalQuarterly Review of Economics and Finance
Volume39
Issue number3
DOIs
Publication statusPublished - 1999

Keywords

  • Commitment
  • Flexibility value
  • Fluctuating uncertainty

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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