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A Real Options Perspective on the Future of the Euro

A break-up of the Eurozone is regarded as inevitable by some. This will be a costly and irreversible decision in conditions of continuing uncertainty, therefore amenable to analysis in the real options framework. We do so by solving as an optimal stopping n−dimensional problem with: (1) country-specific shocks, (2) the “convergence” of member economies, and (3) a complete break-up versus individual country departures. In calibrated solutions for a symmetric case we find a non-negligible but small option value. Furthermore, we find a new theoretical result on the non-monotonicity of abandonment threshold with respect to volatility.

Fernando Alvarez, University of Chicago
Avinash Dixit, Princeton University
Publication Date: 
December, 2012
BFI Initiative: 
Publication Status: