SUMMARY

We demonstrate the valuation of real (investment) options in the presence of endogenous and exogenous learning. Endogenous learning is captured through optimally activated controls arising because of costly managerial actions (R&D, marketing research, advertisement, etc.) intended to enhance value and reveal information. The realization of the controls are jumps with a random size. The decision- maker solves an optimization problem by considering the trade-off between the benefits of the R&D actions and their cost. Exogenous learning is captured through random information arrival of rare events (jumps resulting from technological, competitive, regulatory or political risk shocks, etc.) that follow a Poisson process and have a size drawn from a mixed distribution. In addition, experiential learning is captured by a dynamic volatility similar to that observed in the financial options markets.

7.1 INTRODUCTION

Very little has appeared in the academic literature to capture the ability of managers to intervene in order to add value and/or learn more in the context of the contemporary theory of investments under uncertainty. It has long been known that even pure learning but optional actions should have a positive effect on the value of investment opportunities (see Roberts and Weitzman, 1981). This is clearly observed in practice, as a recent article in Business Week demonstrates the high value of oil exploration rights (Exploiting Uncertainty, Business Week, 7 June 1999, pp. 118 124).

Investment theory under uncertainty is now synonymous with the term real options and the pricing tools...