The impact of insurance in investment strategies: a real options approach

This study aims to understand what a firm's investment strategy should be if the firm considers purchasing insurance. We consider an investment model with two sources of uncertainty. The firm's future revenue is assumed to depend on a random economic indicator, following a Geometric Brownian Motion. On the other hand, unexpected adverse events, that reduce a firm's future revenue, are introduced out, described by a compound Poisson Process. The objective is to decide on the optimal moment for the firm to invest in the market and the insurance contract that it wants to buy. The decision to buy an insurance contract depends on the insurance premium and how the firm measures its risk. We formulate the model as a control problem that is solved using a dynamic programming approach.