European Real Options: An Intuitive Algorithm for the Black-Scholes Formula

7 Pages Posted: 6 Jan 2005  

Vinay T. Datar

Seattle University

Scott H. Mathews

The Boeing Company

Abstract

We propose an intuitive method that is algebraically equivalent to the Black-Scholes formula. The main advantage of this method is its simplicity and transparency. Further, the method implicitly adjusts the discount rate to account for the underlying risk. Our approach relies on information that is available in the traditional project analysis using the net present value technique. When Black-Scholes assumptions are compromised in real projects, our method may provide a better approximation of call value. Our preliminary results suggest that our method provides a reasonable approximation for both binomial and jump diffusion processes where the terminal distributions need not be log-normal.

JEL Classification: G10, G13

Suggested Citation

Datar, Vinay T. and Mathews, Scott H., European Real Options: An Intuitive Algorithm for the Black-Scholes Formula. Journal of Applied Finance, Vol. 14, No. 1, Spring/Summer 2004. Available at SSRN: https://ssrn.com/abstract=560982

Vinay T. Datar (Contact Author)

Seattle University ( email )

900 Broadway
Seattle, WA 98122
United States
206-296-2801 (Phone)
206-296-2486 (Fax)

Scott H. Mathews

The Boeing Company ( email )

PO BOX 3707 MC 45-93
Seattle, WA 98124
United States
206-655-1366 (Phone)

Paper statistics

Downloads
168
Rank
142,317
Abstract Views
3,713