Privatization of businesses and flexible investment: a real option approach

Chavanasporn, W. and Ewald, C. (2012) Privatization of businesses and flexible investment: a real option approach. Decisions in Economics and Finance, 35(1), pp. 75-89. (doi: 10.1007/s10203-011-0115-1)

Abstract

In this article, we study the situation, where the opportunity is given to invest into a government-owned business by partial privatization to a private company. After payment of an initial installment cost, the private company’s investments are flexible within a range [0, k] until the business is completed. We model the problem in a real option framework, using geometric mean reversion to describe the dynamics of the business. We determine the optimal time for the private company to enter and pay the initial installment cost as well as the optimal dynamic investment strategy that it follows afterward. For the latter, analytic solution cannot be obtained. We use quadratic splines in order to solve the corresponding dynamic programming problem. Finally, we determine the optimal degree of privatization in our model from the government’s perspective.

• Item Type: Articles
• Status: Published
• Refereed: Yes
• Glasgow Author(s) Enlighten ID: Ewald, Professor Christian
• Authors: Chavanasporn, W., and Ewald, C.
• College/School: College of Social Sciences > Adam Smith Business School > Accounting and Finance
• Journal Name: Decisions in Economics and Finance
• ISSN: 1593-8883
• ISSN (Online): 1129-6569
• Published Online: 01 May 2011