Optimal Exit From A Deteriorating Project With Noisy Returns

Authors:
Reade Ryan;Steven A. Lippman
Affiliations:
The John E. Anderson School of Management at UCLA, Los Angeles, CA 90095-1481, E-mail: rryan@amaranthllc.com;The John E. Anderson School of Management at UCLA, Los Angeles, CA 90095-1481, E-mail: slippman@anderson.ucla.edu
Venue:
Probability in the Engineering and Informational Sciences
Year:
2005

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Abstract

We consider the problem of determining when to exit an investment whose cumulative return follows a Brownian motion with drift &mgr; and volatility σ2. After an unobserved exponential amount of time, the drift drops from &mgr;H 0 to &mgr;L p*, where the value of p* is given implicitly. We effect a complete comparative statics analysis; one surprising result is that a decrease in &mgr;L is beneficial when |&mgr;L| is large.