Option exercise with temptation

Abstract

This paper adopts the Gul and Pensendorfer self-control utility model to analyze an agent’s option exercise decision under uncertainty over an infinite horizon. The agent decides whether and when to do an irreversible activity. He is tempted by immediate gratification and suffers from self-control problems. The cost of self-control lowers the benefit from continuation or stopping and may erode the option value of waiting. When applied to the investment and exit problems, the model can generate the behavior of procrastination and preproperation. In addition, unlike the hyperbolic discounting model, the model here provides a unique prediction.