Bridging Decision Analysis and Real Options for Practical Valuation
A decision analysis approach to real options valuation that critiques perfect-market assumptions and proposes simpler stochastic models accessible to practitioners.
This paper addresses the challenges of applying complex financial option models to real-world investment decisions. It critiques traditional assumptions — particularly perfect market liquidity — and proposes a decision analysis framework for real options valuation that is more accessible to non-specialist practitioners.
The Accessibility Problem
Standard real options models require continuous-time stochastic calculus, risk-neutral probability measures, and liquid hedging markets. In most real investment contexts, these assumptions fail. The gap between academic rigor and practitioner usability limits adoption.
Proposed Framework
By focusing on opportunity loss and using simpler stochastic models, the method becomes more tractable for practitioners in engineering economics and corporate planning. The paper advocates for blending practical decision-making with risk-neutral valuation techniques to better capture investment flexibility.
Contribution
The resulting framework bridges the gap between academic finance and the real needs of business practitioners, enabling more organizations to capture the value of real options thinking without requiring advanced financial expertise.