The Effect of Jump on Evaluating Natural Resource Investments

Abstract

The evaluation of mining and other natural resource projects is made particularly difficult by the high degree of uncertainty attaching to output prices. It is shown that the techniques of continuous time arbitrage and stochastic control theory may be used not only to value such projects but also to determine the optimal policies for developing managing. This paper describes a model for evaluating natural resource investments under uncertainty from a new perspective. The previous works in this field mostly regard the movements of natural resource prices as a continuous GBM process, which pays few attentions to the shock of unexpected bad news. Our model provides the first theoretical method to analyze the impact of such “jump” on investment decisions. It concludes that the more frequently bad news happens, the earlier a project will be invested.