Real Options: Applications in Public Economics

This paper illustrates the use of real options principles to value prototypical resource and industryinvestment projects. It captures important competitive/strategic dimensions in a step-by-stepanalysis of investment decisions (options) under uncertainty. It compares and contrasts staticdiscounted cash flow analysis (DCF) with real options analysis using three case studies. The initialexample values a resource extraction process using static DCF and then compares the projectvaluation when future information is valued and acted upon. The second example considers a coaldevelopment and uses the binomial valuation approach to capture the option value associated withhaving the right but not the obligation to exit the development. It contrasts this valuation approachagainst static DCF and highlights that future royalty payments could be underestimated if based onthe standard DCF valuation. The third example analyses the impact of providing a subsidy forhybrid vehicle production to accelerate potential uncertain environmental benefits. Lastly, thesuitability of the standard financial and economic evaluation tools used by treasury agencies isconsidered when projects contain real options.financial economics; investment decisions; public economics; externalities; subsidies; project evaluation

Some numerical methods for solving stochastic impulse control in natural gas storage facilities

The valuation of gas storage facilities is characterized as a stochastic impulse control problem with finite horizon resulting in Hamilton-Jacobi-Bellman (HJB) equations for the value function. In this context the two catagories of solving schemes for optimal switching are discussed in a stochastic control framework. We reviewed some numerical methods which include approaches related to partial differential equations (PDEs), Markov chain approximation, nonparametric regression, quantization method and some practitioners’ methods. This paper considers optimal switching problem arising in valuation of gas storage contracts for leasing the storage facilities, and investigates the recent developments as well as their advantages and disadvantages of each scheme based on dynamic programming principle (DPP

An Evaluation of Overseas Oil Investment Projects under Uncertainty Using a Real Options Based Simulation Model

This paper applies real options theory to establish an overseas oil investment evaluation model that is based on Monte Carlo simulation and is solved by the Least Squares Monte-Carlo method. To better reflect the reality of overseas oil investment, our model has incorporated not only the uncertainties of oil price and investment cost but also the uncertainties of exchange rate and investment environment. These unique features have enabled our model to be best equipped to evaluate the value of oil overseas investment projects of three oil field sizes (large, medium, small) and under different resource tax systems (royalty tax and production sharing contracts). In our empirical setting, we have selected China as an investor country and Indonesia as an investee country as a case study. Our results show that the investment risks and project values of small sized oil fields are more sensitive to changes in the uncertainty factors than the large and medium sized oil fields. Furthermore, among the uncertainty factors considered in the model, the investment risk of overseas oil investment may be underestimated if no consideration is given of the impacts of exchange rate and investment environment. Finally, as there is an important trade-off between oil resource investee country and overseas oil investor, in medium and small sized oil investment negotiation the oil company should try to increase the cost oil limit in production sharing contract and avoid the term of a windfall profits tax to reduce the investment risk of overseas oil fields.Overseas Oil Investment, Project Value, Real Options, Least Squares Monte-Carlo

Application of the American Real Flexible Switch Options Methodology A Generalized Approach

The paper deals with the inclusion of flexibility in financial decision-making under risk. It describes the application of the real options methodology with the possibility of sequential multinomial decision-making. The basic intention is to describe and apply a generalized approach and methodology of the flexibility modeling and valuation based on multiple choices and non-symmetrical switching costs under risk. The stochastic dynamic Bellman optimization principle is explained and applied. The optimization criterion of the present expected value is derived and used. Likewise, an option valuation approach based on replication strategy and risk-neutral probability is applied. An illustrative example of the application of the real multinomial flexible non-symmetrical switch options methodology is presented for three chosen modes. The option flexible values are computed. The usefulness, effectiveness, and suitability of applying the generalized flexibility model in company valuation and project evaluation is verified and confirmed. The significance of applying the generalized methodology in transition market economies is discussed and verified.financial options; real options; Discrete Binomial Model; pricing; stochastic dynamic Bellman Optimization Principle; switch options

Flexibility in aluminium production: A real option model

This thesis investigates the value of flexibility in production of aluminium. By the use of real option theory we present a switching option model that measures the value of switching between two modes of production, open and closed. The value of the option is derived through a Least Square Monte Carlo Simulation, by modelling a stochastic process of the underlying risk factors of production, as suggested by Longstaff and Schwartz. Accounting for costs related to switching between modes of production the model derives at an optimal strategy of production. The analysis reveals that the flexibility embedded in real options adds a significant value to the aluminium plant. The result is consistent for several changes in underlying parameters of the model. Further analysis reveals that the value is heavily dependent on the sourcing of power. When including a fixed contract of power for the lifetime of the aluminium plant, we find that the value of a flexible production is significantly reduced.Denne oppgaven undersøker verdien av å ha fleksibilitet i produksjon av aluminium. Ved hjelp av realopsjonsanalyse presenterer vi en opsjonsmodell som gir muligheten til å bytte mellom to ulike driftsmoduser; full drift eller midlertidig nedstenging. Metoden vi bruker er utledet fra Longstaff og Schwartz og er kjent som least square Monte Carlo simulation. Ved å modellere stokastiske prosesser for underliggende risikofaktorer i aluminiumsproduksjon, samt ta høyde for kostnader knyttet til å bytte mellom driftsmoduser, finner vi en optimal driftsstrategi. Det fremkommer av analysen at fleksibilitetene som foreligger i en realopsjon tilfører store verdier til aluminiumsproduksjon. Vi finner at dette er gjeldene for flere endringer av parametre i modellen. Videre viser analysen at verdien på realopsjonen avhenger betydelig av hvilken type kraftskontrakt som blir valgt. Velger man å binde seg til en fast kontrakt for hele levetidet til aluminiumsanlegget, reduserer dette verdien på opsjonen betraktelig til tilnærmet null.Master i okonomi og administrasjo

Business Value of IT Investment: The Case of a Low Cost Airline’s Website

Using the case of a low cost airline company’s website we analyze some special research questions of information technology valuation. The distinctive characteristics of this research are the ex post valuation perspective; the parallel and comparative use of accounting and business valuation approaches; and the integrated application of discounted cash flow and real option valuation. As the examined international company is a strategic user of e-technology and wants to manage and account intangible IT-assets explicitly, these specific valuation perspectives are gaining practical significance

Valuing Joint Ventures Using Real Options

As the valuation of strategic measures becomes increasingly important, relatively few articles have discussed the valuation methods pertained for joint ventures. This paper shows that real options contribute to a better valuation of joint venture projects through superior reflection of the value drivers compared to traditional valuation methodology. Particularly, the strategic value of a joint venture and the value of flexibility that stems from a less than full commitment can be determined using options valuation. Besides reviewing the basics of real options, the paper discusses the key levers of joint ventures and shows the power of real options in the valuation process. We apply four option types (option to defer, option to expand/acquisition option, option to innovate, and option to abandon) to an imaginary joint venture example and show how to use the Black/Scholes and binomial valuation techniques to value these options. Of the four option types, particularly the option to innovate is important, as it allows to reflect the strategic value of a joint venture generating future business opportunities. Despite its advantages, this valuation methodology also has some drawbacks that are discussed in the concluding section.Joint ventures, real options, option valuation, Black/Scholes model, binomial option valuation

An analysis of spending behaviour under liquidity constraints with an application to financial hedging

Imperial Users onl