The Option to Drill Again: Valuing a Sequence of Dependent Trials

17 Pages Posted: 8 Jan 2003

See all articles by James L. Smith

James L. Smith

affiliation not provided to SSRN

Date Written: October 23, 2002

Abstract

We examine the value of a petroleum exploration prospect that is to be exploited via a series of possibly dependent trials. The pattern and strength of dependence among trials is linked to a real option that affects the expected economic value of the prospect. We develop an exact, yet intuitive, expression for the expected value of such a prospect. We also show that two intuitive approaches to valuation provide strict upper and lower bounds for the actual value. Finally, the impact of dependence is shown to be monotonic: each increase in the degree of dependence among trials results in a further reduction in expected value of the prospect.

Keywords: Real option, valuation, oil, exploration

JEL Classification: G12, G31, Q40, D83

Suggested Citation

Smith, James L., The Option to Drill Again: Valuing a Sequence of Dependent Trials (October 23, 2002). Available at SSRN: https://ssrn.com/abstract=353120 or http://dx.doi.org/10.2139/ssrn.353120

James L. Smith (Contact Author)

affiliation not provided to SSRN

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