Optimal investment decision under regulatory and environmental risks

摘要

This paper investigates the decision-making of a firm that has an option to invest from among multiple alternative projects. This type of option is called a max-option, and the nature of a max-option has been investigated in several papers. I extend the previous analysis to a model that allows the random occurrence and disappearance of alternative projects in which to invest. The occurrence and disappearance of investment opportunities will be caused by changes in regulation, exits and entries of rival firms, technological innovation, political risk, catastrophes, etc. By proving the properties of the options, this paper suggests how a firm should deal with regulatory and environmental risks. Specifically, I demonstrate that the prospective future occurrence of an alternative (e.g. as a result of deregulation) has the significant effect of increasing the option value and deferring the investment decision. The results help better understand investment decisions with regulatory and environmental uncertainty.