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Using real option and decision analysis to evaluate investments in the architecture, construction and engineering industry

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  • Francis Ng
  • Hans Bjornsson

Abstract

Many architecture, engineering and construction (AEC) professionals would like to use real option (RO) and decision analysis (DA) to evaluate alternatives in investment in the face of uncertainty. However, they have difficulty deciding which one to use and many are not aware of the subtle differences in assumptions and techniques between the two methodologies. We explain how DA and RO can be applied in complete and incomplete markets and what implicit assumptions we need to be aware of in each scenario. Through a toll road example, it is shown that, in a complete market, DA and RO give the same valuation regardless of the choice of the utility function. A formula is provided for pricing any investment in a complete market. The paper also discusses why the values calculated using DA and RO differ in an incomplete market and when DA is more appropriate than RO and vice versa.

Suggested Citation

  • Francis Ng & Hans Bjornsson, 2004. "Using real option and decision analysis to evaluate investments in the architecture, construction and engineering industry," Construction Management and Economics, Taylor & Francis Journals, vol. 22(5), pages 471-482.
    • Handle: RePEc:taf:conmgt:v:22:y:2004:i:5:p:471-482
    DOI: 10.1080/01446190310001649074
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    Citations

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    Cited by:

    1. João Adelino Ribeiro & Paulo Jorge Pereira & Elisio Moreira Brandão, 2020. "A real options approach to optimal bidding in construction projects considering volume uncertainty," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 41(4), pages 631-640, June.
    2. Ryuta Takashima & Kyoko Yagi & Hiroshi Takamori, 2010. "Government guarantees and risk sharing in public–private partnerships," Review of Financial Economics, John Wiley & Sons, vol. 19(2), pages 78-83, April.
    3. Takashima, Ryuta & Yagi, Kyoko & Takamori, Hiroshi, 2010. "Government guarantees and risk sharing in public-private partnerships," Review of Financial Economics, Elsevier, vol. 19(2), pages 78-83, April.

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