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Toward a General Theory of Real Options

  • Benoit Morel
Chapter
Part of the Springer Climate book series (SPCL)

Abstract

This chapter reviews history of financial option from its origin with Bachelier and continuing with the contributions of Black–Scholes and Merton. The origin of the concept of real option (S. Myers) is also discussed. The relation (conceptual and mathematical) between financial and real option, as well as the concept of risk neutrality and its relevance for real options, is discussed ad nauseam. In the process, a mathematical framework for real option analysis (ROA) is developed. This chapter is somewhat math-intensive. Of particular importance for the rest of the book are the discussions of first-degree homogeneity and risk neutrality and their mathematical implications.

Without the Black–Scholes formula, ROA would probably not exist. It was Black–Scholes who inspired Stewart Myers to introduce the concept of real options in his study of the value of a firm. He emphasized the importance of growth options in the valuation of a firm, and he called those options “real options.” As a result, not only does ROA have its roots in the culture of corporate investments, but it also grew in that cobweb. The downside is that ROA is seen as a mere extension of financial options, when in fact it should be the opposite: financial options being the particularization to the world of finance of a broader concept, real options. When it comes to climate change policy, this distinction is fundamental, because it is what makes ROA applicable there.

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Copyright information

© Springer Nature Switzerland AG 2020

Authors and Affiliations

  • Benoit Morel
    • 1
  1. 1.Carnegie Mellon UniversityPittsburghUSA

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