Publication Type

Journal Article

Version

acceptedVersion

Publication Date

8-2011

Abstract

Traditional real options analysis addresses the problem of investment under uncertainty assuming a risk-neutral decision maker and complete markets. In reality, however, decision makers are often risk averse and markets are incomplete. We confirm that risk aversion lowers the probability of investment and demonstrate how this effect can be mitigated by incorporating operational flexibility in the form of embedded suspension and resumption options. Although such options facilitate investment, we find that the likelihood of investing is still lower compared to the risk-neutral case. Risk aversion also increases the likelihood that the project will be abandoned, although this effect is less pronounced. Finally, we illustrate the impact of risk aversion on the optimal suspension and resumption thresholds and the interaction among risk aversion, volatility, and optimal decision thresholds under complete operational flexibility.

Keywords

Decision analysis, Investment under uncertainty, Real options, Operational flexibility, Risk aversion

Discipline

Operations and Supply Chain Management | Risk Analysis

Research Areas

Operations Management

Publication

European Journal of Operational Research

Volume

213

Issue

1

First Page

221

Last Page

237

ISSN

0377-2217

Identifier

10.1016/j.ejor.2011.03.007

Publisher

Elsevier

Embargo Period

8-29-2021

Additional URL

https://doi.org/10.1016/j.ejor.2011.03.007

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