The Expected Return and Exercise Time of Merton-Style Real Options

15 Pages Posted: 17 May 2002

See all articles by Rafal M. Wojakowski

Rafal M. Wojakowski

University of Surrey; Lancaster University - Management School

Mark B. Shackleton

Lancaster University - Department of Accounting and Finance

Abstract

We analyse the rate of return and expected exercise time of Merton-style options (1973) employed in many real option situations where the possibility of exercise is both perpetual and American in nature. Using risk-neutral and risk-adjusted pricing techniques, Merton-style options are shown to have an expected return that is independent of the option value and independent of the proximity to the critical exercise boundary. Merton options thus remain at the same point on the Security Market Line, unlike European options whose position and rate of return change dynamically. We also present formulae for the expected time and discounted times to exercise and analyse the dependency of these variables on volatility.

Suggested Citation

Wojakowski, Rafal M. and Shackleton, Mark B., The Expected Return and Exercise Time of Merton-Style Real Options. Available at SSRN: https://ssrn.com/abstract=312719

Rafal M. Wojakowski

University of Surrey ( email )

Faculty of Business, Economics and Law
The Surrey Business School
Guildford, Surrey GU2 7XH
United Kingdom
+44 1483 683477 (Phone)

HOME PAGE: http://www.surrey.ac.uk/sbs/people/rafal_wojakowski/index.htm

Lancaster University - Management School ( email )

Lancaster, LA1 4YX
United Kingdom
+44 (1524) 593630 (Phone)
(01524) 847321 (Fax)

HOME PAGE: http://www.lums.lancs.ac.uk/profiles/rafal-wojakowski/

Mark B. Shackleton (Contact Author)

Lancaster University - Department of Accounting and Finance ( email )

The Management School
Lancaster LA1 4YX
United Kingdom
44 1524 594131 (Phone)
44 1524 847321 (Fax)

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