A jump-diffusion real option approach for hotel investment under uncertain lodging demand: The case of Macao
Abstract
Purpose
One of the important characteristics of the hotel business is uncertainty of lodging demand, which can jeopardize hotel operation and ultimately even threaten a hotel’s survival during an economic recession. The purpose of this paper is to propose an approach to determine optimal hotel investment issues under uncertain lodging demand.
Design/methodology/approach
Uncertainty of lodging demand is classified into two types: the impact of unexpected economic recession and the temporary imbalance between supply of hotel rooms and lodging demand. A jump-diffusion real option approach is proposed to analyze how these two types affect optimal investment timing and the potential value of new hotel projects. The case of hotel investment in Macao is used to illustrate the jump-diffusion real option approach.
Findings
The results of numerical analysis show that the uncertainty induced by temporary imbalance between supply of hotel rooms and lodging demand increases the threshold of investment and hotel value, while the uncertainty induced by unexpected economic recession has ambiguous effects on the value and optimal investment timing of new hotel projects.
Practical implications
The jump-diffusion real option approach increases managerial flexibility for managers when making investment decisions on new hotel projects, allowing greater value to be generated than is possible with the conventional discounted cash flow method.
Originality/value
The approach separates the impact of unexpected economic recession on lodging demand from that of “normal” fluctuations in lodging demand, and it considers the impact of both types of uncertainty on hotel investment.
Keywords
Acknowledgements
The authors gratefully acknowledge the editor and two anonymous referees for their invaluable insight and comments which greatly improve the quality of the paper. The authors acknowledge the financial support from Macao Foundation (0485 k). The authors are responsible for any remaining errors.
Citation
Ma, R. and Zhai, P. (2016), "A jump-diffusion real option approach for hotel investment under uncertain lodging demand: The case of Macao", Kybernetes, Vol. 45 No. 10, pp. 1604-1616. https://doi.org/10.1108/K-02-2016-0025
Publisher
:Emerald Group Publishing Limited
Copyright © 2016, Emerald Group Publishing Limited