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Real Options Estimate Using Probabilistic Present Worth Analysis

Author

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  • David Carmichael
  • Ariel Hersh
  • Praneeth Parasu

Abstract

The article presents a method for estimating the value of a real option using probabilistic present worth analysis. The method is shown to capture the upside value of a real option in an equivalent way as—and provide similar results to— the Black-Scholes method. Its strength lies in its intuitive appeal, the avoidance of having to estimate volatility, relaxed assumptions, and the simplicity of the underlying calculations. A comparison with the Black-Scholes method is undertaken in structural terms, with differences noted, and numerically for a range of input parameters. The proposed method is also applicable to evaluating financial options.

Suggested Citation

  • David Carmichael & Ariel Hersh & Praneeth Parasu, 2011. "Real Options Estimate Using Probabilistic Present Worth Analysis," The Engineering Economist, Taylor & Francis Journals, vol. 56(4), pages 295-320.
    • Handle: RePEc:taf:uteexx:v:56:y:2011:i:4:p:295-320
    DOI: 10.1080/0013791X.2011.624259
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    Cited by:

    1. Michael Short & William Peirson & Gregory Peters & Ronald Cox, 2012. "Managing Adaptation of Urban Water Systems in a Changing Climate," Water Resources Management: An International Journal, Published for the European Water Resources Association (EWRA), Springer;European Water Resources Association (EWRA), vol. 26(7), pages 1953-1981, May.
    2. G. D’Amico & R. Blasis & V. Vigna, 2024. "Advertising investments on television: real option estimation through Markov chains," Quality & Quantity: International Journal of Methodology, Springer, vol. 58(5), pages 4661-4678, October.
    3. Gaston Milanesi & Gabriela Pesce & Emilio El Alabi, 2015. "Strategic Asset Valuation: A Model Including Asymmetry and Kurtosis in Its Distribution in Continuous Time," Academic Journal of Economic Studies, Faculty of Finance, Banking and Accountancy Bucharest,"Dimitrie Cantemir" Christian University Bucharest, vol. 1(1), pages 91-104, March.
    4. Carmichael, David G. & Ballouz, Joseph J. & Balatbat, Maria C.A., 2015. "Improving the attractiveness of CDM projects through allowing and incorporating options," Energy Policy, Elsevier, vol. 86(C), pages 784-791.

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