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Article: Operating Leverage and the Interaction between Abandonment Options and Exotic Hedging

TitleOperating Leverage and the Interaction between Abandonment Options and Exotic Hedging
Authors
KeywordsOperating leverage
Abandonment options
Exotic hedging
Issue Date2005
PublisherWorld Scientific Publishing Co Pte Ltd. The Journal's web site is located at http://www.worldscinet.com/jda/jda.shtml
Citation
Journal of Derivatives Accounting, 2005, v. 2 n. 1, p. 87-96 How to Cite?
AbstractThis paper examines the interaction between operational and financial hedging in the context of the competitive firm under output price uncertainty. The firm is endowed with an abandonment option in that its production decision is made after the true realization of the random output price has been observed. If the realized output price is less than its marginal cost, the firm optimally exercises its abandonment option and ceases from production. Otherwise, the firm lets its abandonment option extinguish and produces at its capacity. The existence of the abandonment option is shown to induce the firm to opt for a concave payoff risk-sharing rule that can be perfectly replicated by writing call options with a single strike price set equal to the marginal cost. We derive necessary and sufficient conditions that ensure a positive (negative) effect of operational hedging via the abandonment option on the firm's optimal operating leverage. In contrast, we show that the effect of financial hedging via customized exotic derivatives on the firm's optimal operating leverage is unambiguously positive. These results suggest that the interaction between abandonment options and exotic hedging is multi-dimensional and deserves further scrutiny.
Persistent Identifierhttp://hdl.handle.net/10722/85674
ISSN

 

DC FieldValueLanguage
dc.contributor.authorWong, KPen_HK
dc.date.accessioned2010-09-06T09:07:52Z-
dc.date.available2010-09-06T09:07:52Z-
dc.date.issued2005en_HK
dc.identifier.citationJournal of Derivatives Accounting, 2005, v. 2 n. 1, p. 87-96en_HK
dc.identifier.issn0219-8681en_HK
dc.identifier.urihttp://hdl.handle.net/10722/85674-
dc.description.abstractThis paper examines the interaction between operational and financial hedging in the context of the competitive firm under output price uncertainty. The firm is endowed with an abandonment option in that its production decision is made after the true realization of the random output price has been observed. If the realized output price is less than its marginal cost, the firm optimally exercises its abandonment option and ceases from production. Otherwise, the firm lets its abandonment option extinguish and produces at its capacity. The existence of the abandonment option is shown to induce the firm to opt for a concave payoff risk-sharing rule that can be perfectly replicated by writing call options with a single strike price set equal to the marginal cost. We derive necessary and sufficient conditions that ensure a positive (negative) effect of operational hedging via the abandonment option on the firm's optimal operating leverage. In contrast, we show that the effect of financial hedging via customized exotic derivatives on the firm's optimal operating leverage is unambiguously positive. These results suggest that the interaction between abandonment options and exotic hedging is multi-dimensional and deserves further scrutiny.-
dc.languageengen_HK
dc.publisherWorld Scientific Publishing Co Pte Ltd. The Journal's web site is located at http://www.worldscinet.com/jda/jda.shtmlen_HK
dc.relation.ispartofJournal of Derivatives Accountingen_HK
dc.rightsJournal of Derivatives Accounting. Copyright © World Scientific Publishing Co Pte Ltd.-
dc.rightsElectronic version of an article published as [Journal of Derivatives Accounting, 2005, v. 2 n. 1, p. 87-96] [10.1142/S0219868105000331] © [copyright World Scientific Publishing Company] [http://www.worldscinet.com/jda/jda.shtml]-
dc.rightsCreative Commons: Attribution 3.0 Hong Kong License-
dc.subjectOperating leverage-
dc.subjectAbandonment options-
dc.subjectExotic hedging-
dc.titleOperating Leverage and the Interaction between Abandonment Options and Exotic Hedgingen_HK
dc.typeArticleen_HK
dc.identifier.openurlhttp://library.hku.hk:4550/resserv?sid=HKU:IR&issn=0219-8681&volume=2&spage=87&epage=96&date=2005&atitle=Operating+Leverage+and+the+Interaction+between+Abandonment+Options+and+Exotic+Hedgingen_HK
dc.identifier.emailWong, KP: kpwong@econ.hku.hken_HK
dc.identifier.authorityWong, KP=rp01112en_HK
dc.description.naturepostprint-
dc.identifier.doi10.1142/S0219868105000331-
dc.identifier.hkuros102147en_HK
dc.identifier.volume2-
dc.identifier.issue1-
dc.identifier.spage87-
dc.identifier.epage96-
dc.publisher.placeSingapore-

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