REAL OPTIONS VALUATION FREE
These models are based on some assumptions, which are sometimes difficult to keep due to the specific feature of real investments and real options captured in them (constant volatility, risk free rate, etc.). Real asset value provided by the real option methodology application is given as a sum of two components: present value of directly measurable cash flows and flexibility value, which captures managerial possibilities (real options).Īs mentioned, assets value and future managerial opportunities captured in real options are quantified by financial option valuation models. These future possible decisions (depends on the future state of the world) are modelled as a formal call and put options, which have their value and can be exercised by companys management. capability of management to change past decision or to make new ones in already undertaken projects. Compared to the traditional passive valuation approaches (NPV, IRR, etc.), real option approach takes into consideration two important aspects: (a) riskiness of cash flow generated by the assets and (b) flexibility, i.e. Here, traditional methods and models used for financial option valuation are used for real assets valuation. Real options methodology is a relatively new approach for solution of a wide range of valuation and decision-making issues. Real options Valuation Risk-neutral Transition probabilities Binomial lattice Recombining Non-recombining Volatility In situation when volatility is changing, two approaches overcoming this problem are employed and compared. There are recombining and non-recombining lattice used and constant and increasing volatility are analysed and results compared. In this paper, there is explained how the problem of changing volatility can be considered if binomial lattice and replication strategy is used for real option valuation. Volatility change is a typical feature of real investment projects, where the riskiness of cash flow generated by the project can change significantly during the project life span.
This paper aims at the valuation of real options with changing volatility.
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