Abstract

http://ssrn.com/abstract=240554
 
 

Citations (5)



 
 

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Option Pricing in the Real World: A Generalized Binomial Model with Applications to Real Options


Tom Arnold


University of Richmond - E. Claiborne Robins School of Business

Timothy Falcon Crack


University of Otago - Department of Finance and Quantitative Analysis

August 2000


Abstract:     
We extend a popular binomial model to allow for option pricing using real-world rather than risk-neutral world probabilities. There are three benefits. First, our model allows direct inference about relevant real-world probabilities (e.g. of success in a real-option project, of default on a corporate bond, or of an American-style option finishing in the money). Second, practitioners using our model for corporate real-option applications completely avoid managerial anxiety that competing risk-neutral models generate when they use risk-free discount rates for risky cash flows. Third, our model simplifies option pricing when higher moments (e.g., skewness and kurtosis) appear in asset pricing models.

Number of Pages in PDF File: 54

JEL Classification: A23, G13

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Date posted: December 27, 2000  

Suggested Citation

Arnold, Tom and Crack, Timothy Falcon, Option Pricing in the Real World: A Generalized Binomial Model with Applications to Real Options (August 2000). Available at SSRN: http://ssrn.com/abstract=240554 or http://dx.doi.org/10.2139/ssrn.240554

Contact Information

Thomas M. Arnold
University of Richmond - E. Claiborne Robins School of Business ( email )
1 Gateway Drive
Richmond, VA 23173
United States
804-287-6399 (Phone)
804-289-8878 (Fax)
Timothy Falcon Crack (Contact Author)
University of Otago - Department of Finance and Quantitative Analysis ( email )
Dunedin
New Zealand
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