Real options approach for fashionable and perishable products using stock loan with regime switching

Abstract

We use the real options approach to study the discount price and the optimal call-back time of a recallable air ticket, and the optimal launch time for a fashion product. Two types of uncertainty are considered, the demand uncertainty and the uncertainty of the switch time of the market condition. We propose that the problems can be formulated as a financial stock loan with regime switching and finite maturity. We formulate the stock loan as an American call options with a time-varying strike price. First, we derive the approximate valuation of the stock loan. Then, we formulate the recallable air ticket problem and the launch time of fashion product problem as two different stock loans. The analyses show that a higher (exogenous) regime-switching rate leads to a higher value for the call option, while a lower (exogenous or endogenous) increment rate on the exercise price allows the company to wait longer before exercising the option and thereby obtain a bigger profit. Thus, by obtaining more accurate information, or having better control of these parameters, could help companies to improve their risk management.