A Hedged Monte Carlo Approach to Real Option Pricing

In this work we are concerned with valuing optionalities associated to invest or to delay investment in a project when the available information provided to the manager comes from simulated data of cash flows under historical (or subjective) measure in a possibly incomplete market. Our approach is suitable also to incorporating subjective views from management or market experts and to stochastic investment costs. It is based on the Hedged Monte Carlo strategy proposed by Potters et al (2001) where options are priced simultaneously with the determination of the corresponding hedging. The approach is particularly well-suited to the evaluation of commodity related projects whereby the availability of pricing formulae is very rare, the scenario simulations are usually available only in the historical measure, and the cash flows can be highly nonlinear functions of the prices.Comment: 25 pages, 14 figure