This paper introduces incomplete information and preemption into an equilibrium model of rms facing real investment decisions. The optimal investment strategy may lie anywhere between the zero-NPV trigger level and the optimal strategy of a monopolist, depending on the distribution of competitors ' costs and the implied fear of preemption. Our model implies that the equity returns of rms which hold real options and are subject to preemption will contain jumps and positive skewness.

This paper presents and applies a methodology for valuing electricity derivatives by constructing replicating portfolios from electricity futures and the risk free asset. Futures based replication is argued to be made necessary by the non-storable nature of electricity, which rules out the traditional spot mar-ket, storage-based method of valuing commodity derivatives. Using the futures based approach, valuation formulae are derived for both spark and locational spread options for both geometric Brownian motion and mean reverting price processes. These valuation results are in turn used to construct real options based valuation formulae for generation and transmission assets. Finally, the valuation formula derived for generation assets is used to value a sample of

Designers often seek modular architectures for complex systems so that their systems better accommodate expected changes, have parts that can be developed and evolved without further coordination, and to ease the understanding of complex designs through abstraction of details hidden within modules. However, current design modeling techniques do not effectively support design modularization and evolution analysis. In this paper, we present a framework to enable automatic and quantifiable software modularization and evolution analyses for high-level design abstractions. The framework contributes a model to substantiate the concept of information hiding as a measurable criterion for software designs, an algorithm to extract the dependence structure of an abstract design, and an approach to quantitatively analyzing the changeability of a design. We have imported existing engineering techniques and economic analysis into software, and made these abilities formalized and automated. We illustrate and demonstrate the potential utility of our modeling and analysis techniques by modeling and analyzing several design examples.

Abstract: We examine the effect of air quality regulation on the productivity of some of the most heavily regulated manufacturing plants in the United States, the oil refineries of the Los Angeles (South Coast) Air Basin. We use direct measures of local air pollution regulation in this region to estimate their effects on abatement investment. Refineries not subject to these local environmental regulations are used as a comparison group. We study the period of increased regulation between 1979 and 1992. On average, each regulation cost $3M per plant on compliance dates and a further $5M per plant on dates of increased stringency. We also construct measures of total factor productivity using plant level data which allow us to observe physical quantities of inputs and outputs for the entire population of refineries. Despite the high costs associated with the local regulations, productivity in the Los Angeles Air Basin refineries rose sharply during the 1987-92 period, a period of decreased refinery productivity in other regions. We conclude that measures of the cost of environmental regulation may be significantly overstated. The gross costs may be far greater than the net cost, as abatement may be productive.

We uncover a significant negative correlation between various volatility measures and private investment in developing countries, even when adding the standard control variables. No such correlation is uncovered when the investment measure is the sum of private and public investment spending. Indeed, public investment spending is positively correlated with some measures of volatility. These findings suggest that the detrimental impact of volatility on investment may be easier to detect using disaggregated data. We provide several possible interpretations for our findings. Nonlinearities in preferences or budget constraints can cause volatility to have first-order negative effects on private investment.

Costs and benefits in the distant future---such as those associated with global warming, long-lived infrastructure, hazardous and radioactive waste, and biodiversity---often have little value today when measured with conventional discount rates. We demonstrate that when the future path of this conventional rate is uncertain and persistent (i.e., highly correlated over time), the distant future should be discounted at lower rates than suggested by the current rate. We then use two centuries of data on U.S. interest rates to quantify this effect. Using both random walk and mean-reverting models (which are indistinguishable based on historical data), we compute the certainty-equivalent rate---that is, the single discount rate that summarizes the effect of uncertainty and measures the appropriate forward rate of discount in the future. Using the random walk model, which we consider more compelling, we find that the certainty-equivalent rate falls from 3% now to 2% after 100 years, to 1% af...

I survey and assess the development of continuous-time methods in finance during the last 30 years. The subperiod 1969 to 1980 saw a dizzying pace of development with seminal ideas in derivatives securities pricing, term structure theory, asset pricing, and optimal consumption and portfolio choices. During the period 1981 to 1999 the theory has been extended and modified to better explain empirical regularities in various subfields of finance. This latter subperiod has seen significant progress in econometric theory, computational and estimation methods to test and implement continuous-time models. Capital market frictions and bargaining issues are being increasingly incorporated in continuous-time theory. THE ROOTS OF MODERN CONTINUOUS-TIME METHODS in finance can be traced back to the seminal contributions of Merton ~1969, 1971, 1973b! in the late 1960s and early 1970s. Merton ~1969! pioneered the use of continuous-time modeling in financial economics by formulating the intertemporal consumption and portfolio choice problem of an investor in a stochastic dynamic programming setting.

This paper extends the real options literature by discussing an investment problem, where a firm has to determine optimal investment timing and optimal capacity choice at the same time under conditions of irreversible investment expenditures and uncertainty in future demand. After the project is installed with a certain maximum capacity, this capacity is fixed as an upper boundary to the output and cannot be adjusted later on. It turns out that, in the framework of this once and for all decision, uncertainty in future demand leads to an increase in optimal installed capacity. But on the other hand it causes investment to be delayed to an extent that even small uncertainty makes waiting and accumulation of further information the optimal decision for large ranges of demand. Limiting the capacity which may be installed weakens this extreme effect of uncertainty. 1. Introduction When a firm has the opportunity to invest in a project, its interest is to find the optimal investment strateg...

Evidence on international capital ‡ows suggests that foreign direct investment (FDI) is less volatile than other …nancial ‡ows. To explain this …nding, I model international capital ‡ows under the assumptions of imperfect enforcement of …nancial contracts and inalienability of FDI. Imperfect enforcement of contracts leads to endogenous …nancing constraints and the pricing of default risk. Inalienability implies that it is not as advantageous to expropriate FDI relative to other ‡ows. These features combine to give a risk sharing advantage to FDI over other capital ‡ows. This risk sharing advantage of FDI translates into a lower default premium and lower sensitivity to changes in a country’s …nancing constraint. The model o¤ers the new implication that …nancially constrained countries should borrow relatively more through FDI. This is because FDI is harder to expropriate and not because FDI is more productive or less volatile. Using several creditworthiness and country risk ratings to measure …nancing constraints, I present new evidence linking FDI and …-nancing constraints. Moreover, numerical simulations of the model generate stronger serial correlation for FDI than for other ‡ows into developing countries. This corroborates the

relocation decisions