Optimal Stopping Made Easy

Abstract

This paper presents a simple discrete time model for valuing real options. A short and simple proof of optimal exercise rules for the standard problems in the real options theory is given in the binomial and trinomial models, and more generally, when the underlying uncertainty is modelled as a random walk on a lattice. The method of the paper is based on the use of the expected present value operators. With straightforward modifications, the method works in discrete time-continuous space, continuous time-continuous space and continuous time-discrete space models.

Keywords: Real options, random walks on lattices, expected present value operators

JEL Classification: D81, C61, G12, G31