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Real options with synergies: static versus dynamic policies

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  • M Nishihara

    (Osaka University, Osaka, Japan)

Abstract

We develop a model for determining whether a firm should exercise two real options individually or simultaneously. The simultaneous exercise of both options has synergy of cost savings, while the separate exercise of each option benefits from project flexibility. This trade-off determines the optimal exercise policy. We compare static and dynamic management of multiple real options. A firm under static management determines the type of exercise of real options ex ante; on the other hand, a firm under dynamic management makes the decision at the time of exercise. We show that highly correlated projects increase the option values under both styles of management because a firm is more likely to enjoy the synergy gains of joint investment. We also highlight the advantage of dynamic management over static management for weakly correlated projects.

Suggested Citation

  • M Nishihara, 2012. "Real options with synergies: static versus dynamic policies," Journal of the Operational Research Society, Palgrave Macmillan;The OR Society, vol. 63(1), pages 107-121, January.
    • Handle: RePEc:pal:jorsoc:v:63:y:2012:i:1:p:107-121
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    Cited by:

    1. Alcino Azevedo & Dean Paxson, 2018. "Rivalry and uncertainty in complementary investments with dynamic market sharing," Annals of Operations Research, Springer, vol. 271(2), pages 319-355, December.
    2. Michi Nishihara, 2012. "Real option valuation of abandoned farmland," Review of Financial Economics, John Wiley & Sons, vol. 21(4), pages 188-192, November.
    3. Michi Nishihara, 2018. "Valuation of an R&D project with three types of uncertainty," EURO Journal on Decision Processes, Springer;EURO - The Association of European Operational Research Societies, vol. 6(1), pages 93-113, June.
    4. Nishihara, Michi, 2014. "Preemptive investment game with alternative projects," Economic Modelling, Elsevier, vol. 43(C), pages 124-135.
    5. Wenbo Shi & Tianke Feng, 2016. "Examining supply contracts under cost and demand uncertainties from supplier’s perspective: a real options approach," International Journal of Production Research, Taylor & Francis Journals, vol. 54(1), pages 83-97, January.
    6. Michi Nishihara, 2017. "Valuation of an R&D project with three types of uncertainty," Discussion Papers in Economics and Business 17-15, Osaka University, Graduate School of Economics.
    7. Nishihara, Michi, 2012. "Real option valuation of abandoned farmland," Review of Financial Economics, Elsevier, vol. 21(4), pages 188-192.
    8. Andrejs Čirjevskis, 2021. "Valuing Dynamic Capabilities-Based Synergies with Real Options," JRFM, MDPI, vol. 14(2), pages 1-14, February.

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