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An experimental study on real option strategies


Wang, Mei; Bernstein, Abraham; Chesney, Marc (2010). An experimental study on real option strategies. In: 37th Annual Meeting of the European Finance Association, Frankfurt am Main, Germany, 2010 - 2010, 1-36.

Abstract

We conduct a laboratory experiment to study whether people intuitively use real-option strategies in a dynamic investment setting. The participants were asked to play as an oil manager and make production decisions in response to a simulated mean-reverting oil price. Using cluster analysis, participants can be classified into four groups, which we label as "mean-reverting", "Brownian motion real-option", "Brownian motion myopic real-option", and "ambiguous". We find two behavioral biases in the strategies by our participants: ignoring the mean-reverting process, and myopic behavior. Both lead to too frequent switches when compared with the theoretical benchmark. We also find that the last group behaves as if they have learned to incorporating the true underlying process into their decisions, and improved their decisions during the later stage.

Abstract

We conduct a laboratory experiment to study whether people intuitively use real-option strategies in a dynamic investment setting. The participants were asked to play as an oil manager and make production decisions in response to a simulated mean-reverting oil price. Using cluster analysis, participants can be classified into four groups, which we label as "mean-reverting", "Brownian motion real-option", "Brownian motion myopic real-option", and "ambiguous". We find two behavioral biases in the strategies by our participants: ignoring the mean-reverting process, and myopic behavior. Both lead to too frequent switches when compared with the theoretical benchmark. We also find that the last group behaves as if they have learned to incorporating the true underlying process into their decisions, and improved their decisions during the later stage.

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Additional indexing

Item Type:Conference or Workshop Item (Paper), refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
03 Faculty of Economics > Department of Informatics
Dewey Decimal Classification:330 Economics
000 Computer science, knowledge & systems
Language:English
Event End Date:2010
Deposited On:15 Feb 2011 14:43
Last Modified:07 Dec 2017 07:03
Other Identification Number:1427

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