The generalized perpetual American exchange-option problem

Abstract

This paper revisits a general optimal stopping problem that often appears as a special case in some finance applications. The problem is essentially of the same form as the investment-timing problem of McDonald and Siegel (1986) in which the underlying processes are two correlated geometric Brownian motions (GBMs) with drifts less than the discount rate. By contrast, we attempt to analyze the underlying optimal stopping problem to its full generality without imposing any restriction on the drifts of the GBMs. By extending the first passage time approach of Xia and Zhou (2007) to the current context, we manage to obtain a complete and explicit characterization of the solution to the problem on all possible drift domains. Our analysis leads to a new and interesting observation that the underlying optimal stopping problem admits a two-sided optimal continuation region on some certain parameter domains.