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

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Abstract

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.

Suggested Citation

  • Zdenìk Zmeškal, 2008. "Application of the American Real Flexible Switch Options Methodology A Generalized Approach," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 58(05-06), pages 261-275, August.
    • Handle: RePEc:fau:fauart:v:58:y:2008:i:5-6:p:261-275
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    More about this item

    Keywords

    financial options; real options; Discrete Binomial Model; pricing; stochastic dynamic Bellman Optimization Principle; switch options;
    All these keywords.

    JEL classification:

    • C6 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling
    • C - Mathematical and Quantitative Methods
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • F2 - International Economics - - International Factor Movements and International Business
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • G1 - Financial Economics - - General Financial Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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