Compound Real Option Valuation with Phase-Specific Volatility: A Multi-Phase Mobile Payments Case Study
Technovation, Volume 31, Issues 5-6, May-June 2011, Pages 240-255
17 Pages Posted: 12 Dec 2012 Last revised: 5 Mar 2013
Date Written: October 10, 2010
Multi-staged R&D projects are copy-book cases of compound real options. Traditional compound option models assume a constant volatility over the lifetime of the project. Building on the n-fold compound option model of Cassimon et al. (2004), we extend this model to allow for phase-specific volatility estimates, while preserving the closed-form solution of the model. We illustrate the extended model with a case study of a real option valuation of a multi-stage software application project by a large mobile phone operator and we show how project managers can estimate phase-specific volatilities.
Keywords: R&D, Real options, Compound option model, Phase-specific volatility, Mobile payments
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