Practical guide to real options in discrete time

Details Practical guide to real options in discrete time Practical guide to real options in discrete time

2004-04-05

arxiv.org/abs/cond-mat/0404106v1

Physics

Condensed Matter

Other Condensed Matter

28 pages, 1 figure, submitted to the "Journal of economic Theory"

Scientific paper

Continuous time models in the theory of real options give explicit formulas for optimal exercise strategies when options are simple and the price of an 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.

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