Abstract

http://ssrn.com/abstract=644081
 
 

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Citations (1)



 


 



Real Option Valuation using NPV


Tom Arnold


University of Richmond - E. Claiborne Robins School of Business

Timothy Falcon Crack


University of Otago - Department of Finance and Quantitative Analysis

November 19, 2004



Abstract:     
We show that a careful net present value (NPV) using risk-adjusted discount rates produces a real option valuation identical to that obtained from a risk-neutral option valuation. This general result demonstrates that NPV and risk-neutral option valuation are equivalent. Although equivalent, we argue that in this context the implementation of a traditional risk-adjusted NPV will often be computationally infeasible - for reasons related to sheer volume of disaggregated sample paths. Fortunately, the risk-adjusted option valuation framework of Arnold and Crack (2000) allows this same risk-adjusted NPV to be executed by seamlessly discounting the payoffs to different sample paths using the correct risk-adjusted discount rates. It also allows the analyst to capture physical probability information not available in a risk-neutral valuation.

Number of Pages in PDF File: 16

Keywords: Real option valuation, NPV, risk-adjusted option valuation, risk-neutral option valuation

JEL Classification: G12, G13, G31

working papers series





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Date posted: January 7, 2005  

Suggested Citation

Arnold, Tom and Crack, Timothy Falcon, Real Option Valuation using NPV (November 19, 2004). Available at SSRN: http://ssrn.com/abstract=644081 or http://dx.doi.org/10.2139/ssrn.644081

Contact Information

Thomas M. Arnold (Contact Author)
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
University of Otago - Department of Finance and Quantitative Analysis ( email )
Dunedin
New Zealand
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