Abstract

http://ssrn.com/abstract=644601
 
 

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Valuing Real Options with Implied Binomial Trees


Tom Arnold


University of Richmond - E. Claiborne Robins School of Business

Timothy Falcon Crack


University of Otago - Department of Finance and Quantitative Analysis

Adam Schwartz


Washington 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

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Date posted: January 8, 2005  

Suggested Citation

Arnold, Tom and Crack, Timothy Falcon and Schwartz, Adam, Valuing Real Options with Implied Binomial Trees (October 21, 2004). Available at SSRN: http://ssrn.com/abstract=644601 or http://dx.doi.org/10.2139/ssrn.644601

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
Adam Schwartz
Washington and Lee University - Department of Business Administration ( email )
Lexington, VA 24450
United States
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