%0 Journal Article
%T A Longstaff and Schwartz Approach to the Early Election Problem
%A Elliot Tonkes
%A Dharma Lesmono
%J Advances in Decision Sciences
%D 2012
%I Hindawi Publishing Corporation
%R 10.1155/2012/287579
%X In many democratic parliamentary systems, election timing is an important decision availed to governments according to sovereign political systems. Prudent governments can take advantage of this constitutional option in order to maximize their expected remaining life in power. The problem of establishing the optimal time to call an election based on observed poll data has been well studied with several solution methods and various degrees of modeling complexity. The derivation of the optimal exercise boundary holds strong similarities with the American option valuation problem from mathematical finance. A seminal technique refined by Longstaff and Schwartz in 2001 provided a method to estimate the exercise boundary of the American options using a Monte Carlo method and a least squares objective. In this paper, we modify the basic technique to establish the optimal exercise boundary for calling a political election. Several innovative adaptations are required to make the method work with the additional complexity in the electoral problem. The transfer of Monte Carlo methods from finance to determine the optimal exercise of real-options appears to be a new approach. 1. Introduction This paper is concerned with a new approach for establishing the optimal decision criteria for calling an early election within an electoral environment which permits a government such an option. The problem is predicated on the assumption that a government endures a stochastic level of popularity, and that popularity can be translated into a probability distribution for the likelihood of being returned to government at a general election. This problem has been studied in [1¨C5]. Intuitively, as the government rises higher in the popular opinion polls, it should become more beneficial to call an early election, as a successful election outcome will yield the government another full term in power. However, the decision is not entirely trivial, because calling an election (even when high in the polls) is not entirely risk free, and the government puts in jeopardy their remaining (certain) term in power for an (uncertain) extended period in power. As the popularity polls become higher and the electoral term grows closer to an end, the decision becomes clear to call an early election; as the government¡¯s popularity diminishes, it becomes clear to defer an election. The optimal boundary is the distinct transition point at which the decision is made to call or defer the election, depending on the state. Approaches to establish the optimal boundary for the early election have been
%U http://www.hindawi.com/journals/ads/2012/287579/