Advertisement

Real Options Methods Illustrated

Chapter
  • 1.2k Downloads
Part of the SpringerBriefs in Finance book series (BRIEFSFINANCE)

Abstract

In this chapter we will discuss different approaches to real options pricing. We will start with the analytical solution of the Black-Scholes equation, which will be applied to the case of Netscape. Subsequently, we will present the Cox-Ross-Rubinstein Approach to option pricing, a numerical method for solving dynamic programming problems. Dynamic programming problems are often solved by partial differential equations, which can become very complex and their analytical solutions are even more complex. Therefore, analytical dynamic programming is beyond the scope of this book. But, we will elaborate on numerical dynamic programming using the numerical method of Copeland and Antikarov (2001), which is applied to the case of Portes. This method is a combination of dynamic programming, contingent claims and Monte Carlo simulation. Furthermore, the case of Boeing is used to demonstrate an application of the Monte Carlo simulation approach by Datar and Mathews (2007). We will conclude the discussion on real options approaches with the spreadsheet approach of de Neufville et al. (2006), which includes the use of Monte Carlo simulation in Excel®, and optimizes the decision regarding the design of a parking garage. This final method is more known to the field of engineering, however, it’s a very interesting method to use, because it demonstrates the impact and importance of probability distributions on real options value. We will discuss this in more detail in Chap. 4. The concluding part of this chapter is the evaluation of the real options approaches by discussing the pros and cons of each approach.

Keywords

Cash Flow Stock Price Option Price Real Option Call Option 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

References

Netscape: Black-Scholes

  1. Black F, Scholes M (1973) The pricing of options and corporate liabilities. J Pol Econ 81(3):637–654CrossRefGoogle Scholar
  2. Buckley A, Tse K, Rijken H, Eijgenhuijsen H (2002) Stock market valuation with real options lessons from netscape. Eur Manage J 20(5):512–526CrossRefGoogle Scholar
  3. Copeland T, Antikarov V (2001a) Real options a practitioners guide. TEXERE, New York/LondonGoogle Scholar
  4. Hull JC (2009a) Options, futures and other derivatives, 7th edn. Pearson Prentice Hall, New JerseyGoogle Scholar
  5. Marathe RR, Ryan SM (2005) On the validity of the geometric Brownian motion assumption. Eng Econ J Devoted Prob Capital Invest 50(2):159–192. doi: 10.1080/00137910590949904 Google Scholar
  6. Yen G, Yen EC (1999) On the validity of the Wiener process assumption in option pricing models: contradictory evidence from Taiwan. Rev Quant Finance Account 12(4):327–340. doi: 10.1023/A:1008309307499 CrossRefGoogle Scholar

Option Pricing: Cox, Ross and Rubinstein

  1. Copeland T, Antikarov V (2001b) Real options a practitioner’s guide. TEXERE, New York/LondonGoogle Scholar
  2. Cox JC, Ross SA, Rubinstein M (1979) Option pricing: a simplified approach. J Financ Econ 1460(7):229–263CrossRefGoogle Scholar
  3. Hull JC (2009b) Options, futures and other derivatives, 7th edn. Pearson Prentice Hall, New JerseyGoogle Scholar

The Portes Case: Copeland and Antikarov

  1. Borison A (2005) Real options analysis: where are the Emperor’s clothes? J Appl Corp Finance 17/2:17–31Google Scholar
  2. Copeland T, Antikarov V (2001c) Real options a practitioner’s guide. TEXERE, New York/LondonGoogle Scholar
  3. Copeland T, Antikarov V (2005) Real options: meeting the Georgetown challenge. J Appl Corp Finance 17/2:32–51Google Scholar
  4. Godinho P (2006) Monte Carlo estimation of project volatility for real options analysis. J Appl Finance 16(1), Spring/Summer p 15–30Google Scholar
  5. Haahtela T (2011) Estimating changing volatility in cash flow simulation-based real option valuation with the regression sum of squares error method. J Real Options 1(1):33–52Google Scholar

The Boeing Approach: Datar Mathews

  1. Datar VT, Mathews SH (2004) European real options: an intuitive algorithm for the black-scholes formula. J Appl Finance 14(1), Spring/Summer 2004 p 45–51Google Scholar
  2. Datar VT, Mathews SH (2007) A practical method for valuing real options: the Boeing approach. J Appl Corp Finance 19(2), Spring 2007 p 95–104Google Scholar

Parking Garage: de Neufville, Scholtes and Wang

  1. Hull JC (2009c) Options, futures and other derivatives, 7th edn. Pearson Prentice Hall, New JerseyGoogle Scholar
  2. de Neufville R, Scholtes S, Wang T (2006) Real options by spreadsheet: parking garage case example. ASCE J Infrastruct Syst 12(2):107–111CrossRefGoogle Scholar
  3. Peters L (2016) Impact of probability distributions on real options valuation. J Infrastruct Syst. doi: 10.1061/(ASCE)IS.1943-555X.0000289, 04016005Google Scholar

Copyright information

© Springer International Publishing Switzerland 2016

Authors and Affiliations

  1. 1.Applied EconomicsUniversity of AntwerpAntwerpBelgium

Personalised recommendations