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Abstract

The primary aim of this thesis is to analyse and provide insights into several critical issues related to the construction, interpretation, and implications of market entry and exit decision models under uncertainty. As discussed by Brennan and Schwartz (1985), Dixit and Pindyck (1994), and Hackbarth and Johnson (2015), operational flexibility refers to the capacity to adjust production in response to market fluctuations with a certain degree of reversibility. In line with this framework, this thesis approaches operational flexibility from three perspectives; each one is examined in a separate chapter and constitutes a different piece of research.

The first chapter explores optimal strategies for managing production projects and the effects of different price models on when to suspend, resume or permanently cease operations. The analysis is conducted calculating the optimal transition barriers, the probabilities of switching between states and the time spent in each. Results suggest that, when dealing with moderately volatile markets, modelling prices by means of simpler processes for ease of use could be acceptable, as this would not significantly impact firms strategic decisions.

The second chapter provides a theoretical basis for understanding the relationship between operational flexibility and the risk-return characteristics of firms equity. Consistently with intuition, more flexible production projects exhibit higher equity value and lower risk. Implications for risk management and asset pricing pertain a subsequent decrease in the implied volatility of option contracts and in CAPM’s β. Importantly, the stochastic nature of the latter is also documented. Moreover, findings are robust across different price diffusion models.

The third chapter investigates the impact of a stochastic convenience yield on flexible projects as a primary scope. The analysis considers a gas-fired turbine for electricity generation that can be switched-off and on at multiple dates in the short term; uncertainty concerns both electricity and gas prices. Findings document that operational flexibility partially offsets the aleatory behaviour of gas’ convenience yield, whose impact is, instead, sizeable when flexibility is not available. Bivariate and trivariate trees are used to deal with the model, making this work particularly attractive for use by practitioners.

Publication Type:	Thesis (Doctoral)
Subjects:	H Social Sciences > HB Economic Theory H Social Sciences > HF Commerce H Social Sciences > HG Finance
Departments:	Bayes Business School > Bayes Business School Doctoral Theses Bayes Business School > Finance Doctoral Theses

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