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Real options

real options

This research considers the valuation of investments under uncertainty. We value options embedded in investments ("real options") such as entry, growth, disinvestment and abandonment options. We also incorporate strategic behaviour between firms into the valuation framework. Strategic behaviour can result from first mover's advantages (e.g. patent races or pre-emptive market entry) or from second mover's advantages (e.g. war of attrition games between firms in declining industries). The work also analyses investors' decisions under different information structures (complete, incomplete and asymmetric information). For example, how does incomplete or asymmetric information about a competitor's cost structure affect a firm's decision to enter a market?

More recent work develops a real options model of a firm's make-or-buy decision under demand uncertainty. The model examines when it is optimal to produce in-house, when to outsource production, or when to combine both ("concurrent sourcing"). "Making" is subject to decreasing returns to scale, fixed costs, and capital investment. "Buying" happens at a fixed price and requires no investment. Three distinct procurement regimes endogenously arise: buying, making, or concurrent sourcing for, respectively, low, intermediate, and high demand. Capital constraints encourage buying or concurrent sourcing. Operating leverage peaks when the firm switches between buying and making, and it is lowest (and negative) at the switch between making and concurrent sourcing. This non-monotonic pattern mirrors and drives the behaviour of the firm's beta. The model helps explain some of the time series patterns in outsourcing activity.

Lambrecht, B.M. (2017) "Real options in finance." Journal of Banking and Finance (DOI: 10.1016/j.jbankfin.2017.03.006) (published online Mar 2017; forthcoming in print)

Lambrecht, B.M., Pawlina, G. and Teixeira, J.C.A. (2016) "Making, buying, and concurrent sourcing: implications for operating leverage and stock beta." Review of Finance, 20(3): 1013-1043 (DOI: 10.1093/rof/rfv027)

Lambrecht, B.M. and Pawlina, G. (2010) "Corporate finance and the (in)efficient exercise of real options." Multinational Finance Journal, 14(1-2): 129-156

Hsu, Y.-W. and Lambrecht, B.M. (2007) "Preemptive patenting under uncertainty and asymmetric information." Annals of Operations Research, 151(1): 5-28 (DOI: 10.1007/s10479-006-0125-5)

Lambrecht, B. and Perraudin, W. (2003) "Real options and preemption under incomplete information." Journal of Economic Dynamics and Control, 27(4): 619-643

Lambrecht, B.M. (2001) "The impact of debt financing on entry and exit in a duopoly." Review of Financial Studies, 14(3): 765-804