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Valuing Real Options with Implied Binomial TreesTom ArnoldUniversity of Richmond - E. Claiborne Robins School of Business Timothy Falcon CrackUniversity of Otago - Department of Finance and Quantitative Analysis Adam SchwartzWashington and Lee University - Department of Business Administration October 21, 2004 Abstract: We value a real option (a lease) using an implied binomial tree (IBT). IBTs use information embedded in the prices of traded options to calibrate a pricing tree for valuing other options on the same underlying asset. By doing so, IBTs capture excess skewness and kurtosis in the underlying asset return distribution. Traditional binomial trees ignore this information and this can lead to biased option prices. The IBT calibration is attractive because it is easy to implement relative to analytical models that capture excess skewness and kurtosis through estimation of Poisson jumps or a model of stochastic volatility.
Number of Pages in PDF File: 13 Keywords: Real Options, Implied Binomial Trees JEL Classification: G12, G13, G31 working papers seriesDate posted: January 8, 2005Suggested CitationContact Information
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