Simplifying Real Options Valuation with Decision Analysis
A decision analysis framework that simplifies real options valuation, with new formulas adjusting for different market behaviors and non-liquid real asset trading challenges.
This work critiques the complexity of traditional real options models and proposes a decision analysis framework as a practical alternative. The primary goal is to make rigorous options-based investment analysis accessible to practitioners who lack advanced financial training.
The Problem with Standard Models
Traditional real options models rely on continuous hedging arguments that require liquid markets for the underlying asset. Most real investments — equipment, technology, infrastructure — do not trade in liquid markets, making direct application of financial options theory problematic.
New Formulas for Real Markets
The paper offers new formulas that adjust for different market behaviors, particularly the challenges of trading non-liquid real assets. It validates the use of risk-neutral pricing even without perfect market assumptions, extending the reach of the framework.
Bridging Theory and Practice
The resulting approach bridges the gap between academic finance and the practical needs of business decision-makers, offering a tool that is both theoretically grounded and operationally tractable.