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This article addresses the investment and financing decisions of entrepreneurs entering into option‐for‐guarantee swaps (OGSs). OGSs increase investment option value significantly. Entrepreneurs initially accelerate their investments and then postpone them as funding gaps grow. Guarantee costs increase with project risks when the funding gap is sufficiently small or large, but the opposite holds true otherwise. Investments are postponed when project risks, effective tax rates, or bankruptcy costs increase. Surprisingly, the higher the project risk, the more the entrepreneur will borrow, with a much higher leverage than predicted by classic models. Entrepreneurs can use OGSs to securitize their assets. [ABSTRACT FROM AUTHOR]

We consider the irreversible investment in a project which generates a cash flow following a double exponential jump-diffusion process and its expected return is governed by a continuous-time two-state Markov chain. If the expected return is observable, we present explicit expressions for the pricing and timing of the option to invest. With partial information, i.e. if the expected return is unobservable, we provide an explicit project value and an integral-differential equation for the pricing and timing of the option. We provide a method to measure the information value, i.e. the difference between the option values under the two different cases. We present numerical solutions by finite difference methods. By numerical analysis, we find that: (i) the higher the jump intensity, the later the option to invest is exercised, but its effect on the option value is ambiguous; (ii) the option value increases with the belief in a boom economy; (iii) if investors are more uncertain about the economic environment, information is more valuable; (iv) the more likely the transition from boom to recession, the lower the value of the option; (v) the bigger the dispersion of the expected return, the higher the information value; (vi) a higher cash flow volatility induces a lower information value. [ABSTRACT FROM AUTHOR]

We study the impact of ambiguity on the pricing and timing of the option to invest. There is a funding gap to undertake the investment, which is covered by entering into an equity-forguarantee swap. Our model predicts that the more ambiguity-averse the agents, the less the option value, the later the investment and the higher the guarantee cost and the leverage. If the entrepreneur is more ambiguity-averse than the insurer, the investment threshold slightly rises as the perceived ambiguity increases, and on the contrary, if the entrepreneur is less ambiguity-averse than the insurer, the investment threshold increases sharply as the perceived ambiguity rises. [ABSTRACT FROM AUTHOR]

We consider an investment option, of which the sunk cost is financed by entering into a fee-for-guarantee swap (FGS) or equity-for-guarantee swap (EGS). Debt has a finite maturity and guarantee costs depend on negotiation. We explicitly derive guarantee costs and the pricing and timing of the option. Under negotiation, borrowers get partial option value depending on his bargaining power and insurers gain the remaining value. We discover that EGSs are better than FGSs in borrowers’ view. Guarantee costs generally increase with funding gaps and investment thresholds decrease with debt maturities. The option value decreases first and then increases with debt maturity. [ABSTRACT FROM AUTHOR]

The equity-for-guarantee swap (EGS) is a new popular financial derivative. We derive closed-form solutions for the interaction of the optimal investment and financing with the swap in a real-options framework. We find that there is an U-shaped relationship between investment timing and the coupon payment. In contrast to the classical model, EGS induces different investment and financing strategies. In particular, it delays investment. Whether the swap leads to debt overhang distortion depends on guarantee cost and the profitability of the project but it induces the borrower’s risk-shifting incentive. The larger the guarantee cost, the stronger the incentive. [ABSTRACT FROM AUTHOR]