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Article: The effects of abandonment options on operating leverage and forward hedging

TitleThe effects of abandonment options on operating leverage and forward hedging
Authors
KeywordsAbandonment options
Forwards
Operating leverage
Options
Issue Date2006
PublisherElsevier BV. The Journal's web site is located at http://www.elsevier.com/locate/iref
Citation
International Review Of Economics And Finance, 2006, v. 15 n. 1, p. 72-86 How to Cite?
AbstractThis paper examines the behavior of the competitive firm under output price uncertainty when the firm is endowed with an abandonment option and has access to a forward market for its output. When the realized output price is less than its marginal cost, the firm optimally exercises its abandonment option and ceases production. The firm lets its abandonment option extinguish, thereby producing up to its capacity, only when the realized output price exceeds its marginal cost. The ex post exercising of the abandonment option as such convexifies the firm's ex ante profit with respect to the random output price. We show that neither the separation theorem nor the full-hedging theorem holds in the presence of the abandonment option. The firm under-hedges its output price risk exposure in the forward market wherein the forward price contains a nonpositive risk premium. When the set of hedging instruments is expanded to include options, we show that both the separation and full-hedging theorems are restored. We further show that the firm prefers options to forwards for hedging purposes when both types of contracts are fairly priced. © 2004 Elsevier Inc. All rights reserved.
Persistent Identifierhttp://hdl.handle.net/10722/85516
ISSN
2015 Impact Factor: 1.846
2015 SCImago Journal Rankings: 0.890
References

 

DC FieldValueLanguage
dc.contributor.authorWong, KPen_HK
dc.date.accessioned2010-09-06T09:06:04Z-
dc.date.available2010-09-06T09:06:04Z-
dc.date.issued2006en_HK
dc.identifier.citationInternational Review Of Economics And Finance, 2006, v. 15 n. 1, p. 72-86en_HK
dc.identifier.issn1059-0560en_HK
dc.identifier.urihttp://hdl.handle.net/10722/85516-
dc.description.abstractThis paper examines the behavior of the competitive firm under output price uncertainty when the firm is endowed with an abandonment option and has access to a forward market for its output. When the realized output price is less than its marginal cost, the firm optimally exercises its abandonment option and ceases production. The firm lets its abandonment option extinguish, thereby producing up to its capacity, only when the realized output price exceeds its marginal cost. The ex post exercising of the abandonment option as such convexifies the firm's ex ante profit with respect to the random output price. We show that neither the separation theorem nor the full-hedging theorem holds in the presence of the abandonment option. The firm under-hedges its output price risk exposure in the forward market wherein the forward price contains a nonpositive risk premium. When the set of hedging instruments is expanded to include options, we show that both the separation and full-hedging theorems are restored. We further show that the firm prefers options to forwards for hedging purposes when both types of contracts are fairly priced. © 2004 Elsevier Inc. All rights reserved.en_HK
dc.languageengen_HK
dc.publisherElsevier BV. The Journal's web site is located at http://www.elsevier.com/locate/irefen_HK
dc.relation.ispartofInternational Review of Economics and Financeen_HK
dc.rightsInternational Review of Economics & Finance. Copyright © Elsevier BV.en_HK
dc.subjectAbandonment optionsen_HK
dc.subjectForwardsen_HK
dc.subjectOperating leverageen_HK
dc.subjectOptionsen_HK
dc.titleThe effects of abandonment options on operating leverage and forward hedgingen_HK
dc.typeArticleen_HK
dc.identifier.openurlhttp://library.hku.hk:4550/resserv?sid=HKU:IR&issn=1059-0560&volume=15&spage=72&epage=86&date=2006&atitle=The+Effects+of+Abandonment+Options+on+Operating+Leverage+and+Forward+Hedgingen_HK
dc.identifier.emailWong, KP: kpwongc@hkucc.hku.hken_HK
dc.identifier.authorityWong, KP=rp01112en_HK
dc.description.naturelink_to_subscribed_fulltext-
dc.identifier.doi10.1016/j.iref.2004.10.004en_HK
dc.identifier.scopuseid_2-s2.0-33144455241en_HK
dc.identifier.hkuros134252en_HK
dc.relation.referenceshttp://www.scopus.com/mlt/select.url?eid=2-s2.0-33144455241&selection=ref&src=s&origin=recordpageen_HK
dc.identifier.volume15en_HK
dc.identifier.issue1en_HK
dc.identifier.spage72en_HK
dc.identifier.epage86en_HK
dc.publisher.placeNetherlandsen_HK
dc.identifier.scopusauthoridWong, KP=7404759417en_HK

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