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The Tourinho model: neglected nugget or a receding relic?

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  • Roger Adkins
  • Dean Paxson

Abstract

This article evaluates Tourinho's (1979b) work as one of the earliest contributors to the real options literature. His model pioneered the application of risk neutrality to uncertain investments, but his originality of introducing an option-holding cost albeit to overcome the extraction paradox is rarely imitated. We claim that the combination of a convenience yield and an option-holding cost produces a more satisfying representation. Moreover, variations in the holding cost give rise to a host of investment decisions ranging from the standard real option solution for a zero-holding cost to a net present value solution for an infinite-holding cost. Not only does the holding cost mediate between these two poles, but it provides the option seller (usually a landowner or a government) with a policy instrument for influencing the extraction timing and thus the extraction profit of the option buyer. We derive the holding cost that optimizes the landowner's combined value of the option premium, holding costs and eventual royalties.

Suggested Citation

  • Roger Adkins & Dean Paxson, 2013. "The Tourinho model: neglected nugget or a receding relic?," The European Journal of Finance, Taylor & Francis Journals, vol. 19(7-8), pages 604-624, September.
    • Handle: RePEc:taf:eurjfi:v:19:y:2013:i:7-8:p:604-624
    DOI: 10.1080/1351847X.2011.601873
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    Cited by:

    1. Adkins, Roger & Paxson, Dean, 2019. "Rescaling-contraction with a lower cost technology when revenue declines," European Journal of Operational Research, Elsevier, vol. 277(2), pages 574-586.
    2. Alexander, Carol & Chen, Xi & Ward, Charles, 2021. "Risk-adjusted valuation for real option decisions," Journal of Economic Behavior & Organization, Elsevier, vol. 191(C), pages 1046-1064.
    3. Roger Adkins & Dean Paxson, 2016. "Subsidies for Renewable Energy Facilities under Uncertainty," Manchester School, University of Manchester, vol. 84(2), pages 222-250, March.
    4. Carol Alexander & Xi Chen, 2021. "Model risk in real option valuation," Annals of Operations Research, Springer, vol. 299(1), pages 1025-1056, April.

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