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- Title
Alternative Approaches for Solving Real-Options Problems.
- Authors
Smith, James E.
- Abstract
Brandao et al. (2005) describe an approach for using traditional decision analysis tools to solve real-option valuation problems. Their approach calls for a mix of discounted cash flow analysis and risk-neutral valuation methods and is implemented using Monte Carlo simulation and binomial decision trees. In this note, I critique their approach and discuss some alternative approaches for solving these kinds of problems. My criticisms and suggestions concern implementation issues as well as more fundamental issues. On implementation, I discuss the use of binomial lattices instead of trees, and alternative methods for estimating volatilities. More fundamentally, I discuss alternative approaches that rely entirely on risk-neutral valuation and model the uncertainties in the problem more directly.
- Subjects
VALUATION; DEBT-to-equity ratio; REAL options (Finance); OPTIONS (Finance); LOAN impairment; CREDIT management
- Publication
Decision Analysis, 2005, Vol 2, Issue 2, p89
- ISSN
1545-8490
- Publication type
Article
- DOI
10.1287/deca.1050.0041