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An experimental study on real option strategies


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

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 ‘mean-reverting’, ‘Brownian motion real-option’, ‘Brownian motion myopic real-option’, and ‘ambiguous’. We find two behavioral biases in the strategies of 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 incorporate 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 ‘mean-reverting’, ‘Brownian motion real-option’, ‘Brownian motion myopic real-option’, and ‘ambiguous’. We find two behavioral biases in the strategies of 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 incorporate the true underlying process into their decisions, and improved their decisions during the later stage.

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Additional indexing

Item Type:Journal Article, 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
Scopus Subject Areas:Social Sciences & Humanities > Finance
Social Sciences & Humanities > General Economics, Econometrics and Finance
Language:English
Date:15 November 2012
Deposited On:19 Sep 2011 11:09
Last Modified:27 Jan 2022 15:19
Publisher:Taylor & Francis
Series Name:NCCR FINRISK Working Paper Series
Number of Pages:38
ISSN:1469-7688
OA Status:Green
Publisher DOI:https://doi.org/10.1080/14697688.2012.691984

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