The analysis utilizes electricity price as the underlying. We provide a new framework for valuing multidimensional real options where opportunities to exercise the option are generated by an exogenous Poisson process, which can be viewed as a liquidity constraint on decision times. The example case is then extended by using the mean reverting stochastic process for the project value and cash flows using the censored binomial presented by Hahn (2005) and the non-censored binomial presented by Bastian-Pinto, Brandão, and Hahn (2010).įinally, the case is valued with a simple, European option equivalent, Monte Carlo approach with the underlying factors following geometric Brownian Motion and mean reverting models, and the results are compared. The algorithm accounts for early exercise values and is thus intended to value American real options. Using real options theory, decision-makers are able to evaluate managerial flexibility using the value of an investment and its risk profile (Kulatilaka et al. Typically, these options give their holders the right to purchase or sell an underlying debt. A comprehensive analysis is conducted to identify the value drivers of options, including timing-aspects, intrinsic option value versus the value of flexibility, sensitivities of the binomial model to interest rate and volatility, and revision of volatility estimates for the BDH case. Price-Based Option: A derivative financial instrument in which the underlying asset is a debt security. Wirjanto (2010), Contrasting two approaches in real options valuation: Contingent claims versus dynamic programming, Journal of. The binomial real options valuation approach using the market asset disclaimer assumption with an emphasis on state-dependent cash flows is reviewed and implemented using geometric Brownian Motion as the stochastic process for project uncertainty and the cash flows.
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