Practical Guide to Real Options in Discrete Time
28 Pages Posted: 6 Mar 2004
Date Written: February 24, 2004
Continuous time models in the theory of real options give explicit formulas for optimal exercise strategies when options are simple and the price of the underlying asset follows a geometric Brownian motion. This paper suggests a general, computationally simple approach to real options in discrete time. Explicit formulas are derived even for embedded options. Discrete time processes reflect the scarcity of observations in the data, and may account for fat tails and skewness of probability distributions of commodity prices. The method of the paper is based on the use of the expected present value operators.
Note: An updated version of this abstract can be found at: http://ssrn.com/abstract=642262
Keywords: Real options, embedded options, expected present value operators
JEL Classification: D81, C61, G31
Suggested Citation: Suggested Citation