Entry and exit decisions with linear costs under uncertainty

Abstract

From the viewpoint of stochastic programming, we rigorously analyse entry and exit decisions of a project which were proposed by Dixit [A. Dixit, Entry and exit decisions under uncertainty, J. Polit. Econ. 97 (1989), pp. 620–638]. In this article, instead of assuming that the costs are constant in classical research, we assume that they are linear with respect to the price of the commodity produced by the project. Under this assumption, we obtain a condition which guarantees that investing in the project is worthless; besides, the project may be terminated when the commodity price is greater than a certain value. In contrast, there are no such results provided that the costs are constant. Moreover, we provide an explicit solution of entry and exit decisions if the project is worthy to be invested in.

Keywords::

• stochastic programming
• optimal stopping
• entry times
• exit times

AMS Subject Classification::

• 60G40
• 60H30

Acknowledgements

The author is grateful to the reviewers for their constructive suggestions and valuable comments.