Smooth pasting as rate of return equalization

Shackleton, Mark B.; Sødal, Sigbjørn

doi:10.1016/j.econlet.2005.05.028

Cited by 33 publications

(15 citation statements)

References 9 publications

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“…See also Eq. (11).4 Shackleton and Sødal (2005) show that smooth pasting implies rate of return equalization between the option and the levered position that results from exercise.…”

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confidence: 96%

The effect of uncertainty on investment timing in a real options model

Wong

2007

Journal of Economic Dynamics and Control

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This paper examines the effect of uncertainty on investment timing in a canonical real options model. We show that the critical value of a project that triggers the exercise of the investment option exhibits a U-shaped pattern against the volatility of the project. This is due to the two countervailing risk and return factors in effect. We further show that such a Ushaped pattern is inherited by the expected time to exercise the investment option. Thus, for relatively safe projects, greater uncertainty shortens the expected exercise time and thus enhances investment. This is in sharp contrast to the negative investment-uncertainty relationship commonly found in the extant literature. Finally, we show that the positive investment-uncertainty relationship is more likely for high growth projects than for low growth projects.

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“…See also Eq. (11).4 Shackleton and Sødal (2005) show that smooth pasting implies rate of return equalization between the option and the levered position that results from exercise.…”

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confidence: 96%

The effect of uncertainty on investment timing in a real options model

Wong

2007

Journal of Economic Dynamics and Control

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“…Smith and Warner (1979) argue that debt may be called early to get rid of restrictive covenants on the firm's investment policy. Kraus (1983), Fisher et al (1989, and Mauer (1993) argue that calls are delayed because of transaction costs.…”

Section: Fundamental Views On the Call Policymentioning

confidence: 99%

“…These two conditions are satisfied for most option pricing models. 6 Equation (2) states that the marginal continuation value (left-hand side of equation) equals the marginal value of exercising the call option (right-hand side of equation) (seeShackleton and Sodal 2005).…”

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confidence: 99%

Prepayment risk on callable bonds: theory and test

François

Pardo

2015

Decisions Econ Finan

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We develop a framework for analyzing prepayment risk on defaultable callable bonds. We argue that prepayment risk emanates from the following informational asymmetry: Callable bond traders cannot determine the issuer's firm valuemaximizing call policy, and their best anticipation is the optimal refinancing policy given by a term structure model. We show that, from the callable bond holder perspective, the issuer's departure from the optimal refinancing policy translates into an accrued exposure to market risk. The prepayment risk magnitude represents this risk transfer, and we show that callable bond traders can infer it from observable bond characteristics. Tests on callable bond transaction data provide strong evidence for prepayment risk and validate our conjecture that insurance companies trade callable bonds to reduce their exposure to prepayment risk magnitude.

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“…Amongst other commentators on the technique,Shackleton and Sødal (2005) show that smooth pasting implies continuity of the rate of return on the strategy's value, before and after the transition.M.B. Shackleton, S. Sødal / Journal of Economic Dynamics & Control 34 (2010) 2533-2546…”

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confidence: 97%