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An experimental study on real options strategies


Wang, Mei; Bernstein, Abraham; Chesney, Marc (2012). An experimental study on real options strategies. Quantitative Finance, 12(11):1753-1772.

Abstract

We conduct a laboratory experiment to study whether people in- tuitively use real-option strategies in a dynamic investment setting. The participants were asked to play as an oil manager and make pro- duction 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 behaved as if they have learned to incor- porate 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 in- tuitively use real-option strategies in a dynamic investment setting. The participants were asked to play as an oil manager and make pro- duction 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 behaved as if they have learned to incor- porate the true underlying process into their decisions, and improved their decisions during the later stage.

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Citations

1 citation in Web of Science®
2 citations in Scopus®
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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Informatics
Dewey Decimal Classification:000 Computer science, knowledge & systems
Language:English
Date:2012
Deposited On:30 Apr 2012 09:22
Last Modified:05 Apr 2016 15:47
Publisher:Taylor & Francis
ISSN:1469-7688
Publisher DOI:https://doi.org/10.1080/14697688.2012.691984
Official URL:http://www.tandfonline.com/doi/abs/10.1080/14697688.2012.691984
Other Identification Number:merlin-id:6938

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