Real Options Valuation with Multiple Uncertainties Using K-Dimensional Models

Posted: 30 Apr 2021

Date Written: July 31, 2019

Abstract

The binomial model presents a set of properties that make it a suitable approach in order to value the real options, throughout an easy and practical application. This is possible by the adaptation of the valuation principle for non-arbitrage, own of the options pricing theory. However, their adoption may be limited for those options that have multiple sources of uncertainty, given that their interaction should be incorporated into the valuation process. In response, financial theory has proposed valuation approaches that allow different sources of uncertainty to be represented by a consolidated estimate of volatility, such as the Marketed Asset Disclaimer (mad) approach developed by Copeland and Antikarov (2001). As an alternative, a treatment that incorporates the dynamics of each uncertainty can be given. In this context, there are different proposals that extend the Binomial model to k-dimensional or multi-dimensional context. To achieve the application, it is necessary an approximation of the k-dimensional stochastic process, as well as its correlations. This paper presents a concise review of the different methods proposed in this context, as well as their benefits, limitations and, some alternative approaches.

Keywords: real options; k-dimensional process; valuation

JEL Classification: C63, G12, G13

Suggested Citation

Zapata Quimbayo, Carlos, Real Options Valuation with Multiple Uncertainties Using K-Dimensional Models (July 31, 2019). Available at SSRN: https://ssrn.com/abstract=3823927

Carlos Zapata Quimbayo (Contact Author)

Universidad Externado de Colombia ( email )

Calle 12 No. 1-17 Este
Bogotá D.C., DC
Colombia
3537000 (Phone)

HOME PAGE: http://www.uexternado.edu.co/finanzas_gob/

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