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Investment under uncertainty and volatility estimation risk

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  • George Dotsis
  • Vasiliki Makropoulou
  • Raphael Nicholas Markellos

Abstract

This article considers the implications of volatility estimation risk in real options theory. We construct confidence intervals for critical project values and options prices. An empirical example in lease investment evaluation for an offshore petroleum tract shows that confidence intervals can be substantial when a limited amount of data are used to estimate volatility.

Suggested Citation

  • George Dotsis & Vasiliki Makropoulou & Raphael Nicholas Markellos, 2012. "Investment under uncertainty and volatility estimation risk," Applied Economics Letters, Taylor & Francis Journals, vol. 19(2), pages 133-137, February.
    • Handle: RePEc:taf:apeclt:v:19:y:2012:i:2:p:133-137
    DOI: 10.1080/13504851.2011.570697
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    References listed on IDEAS

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    1. Davis, Graham A., 1998. "Estimating Volatility and Dividend Yield When Valuing Real Options to Invest or Abandon," The Quarterly Review of Economics and Finance, Elsevier, vol. 38(3, Part 2), pages 725-754.
    2. James L. Paddock & Daniel R. Siegel & James L. Smith, 1988. "Option Valuation of Claims on Real Assets: The Case of Offshore Petroleum Leases," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 103(3), pages 479-508.
    3. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-157, April.
    4. Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 101(4), pages 707-727.
    5. Boyle, Phelim P. & Ananthanarayanan, A. L., 1977. "The impact of variance estimation in option valuation models," Journal of Financial Economics, Elsevier, vol. 5(3), pages 375-387, December.
    6. Lo, Andrew W., 1986. "Statistical tests of contingent-claims asset-pricing models : A new methodology," Journal of Financial Economics, Elsevier, vol. 17(1), pages 143-173, September.
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