Real Options

in the Real Volatile World

Mitigate Uncertainty

Imagine that an oil production firm is extracting oil in West Texas, and sees a sudden decline of oil prices in the market that produces negative cash flows for its operations. Should the firm choose the option of aban- doning the unprofitable oil well or continuing the operations at a short-term loss? Is there any value of continuing production at negative net present values (NPVs) to keep the option open for a market come- back? This example illustrates the basic question investigated in this study: How to measure the value of managerial flexibility affected by extreme volatility in proposed or existing operations?

Expert taken from: Real Options in the Real Volatile World.

Read the Article

Real Options in the Real Volatile World was published in the POM Journal. You can read the article here.

Introduction

Motivated by the real-world challenges of real options evaluation faced by many companies when commodity prices exhibit dramatic volatility and project values can become negative, this study presents a framework for solving a multifactor real options problem by approximating the underlying stochastic process of project value with a generalized implied binomial tree.

Expert taken from: Real Options in the Real Volatile World.

Video Resources

This article focused on the oil and gas industry. How can other industries apply the real options literature?

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Dr. Tianyang Wang

Associate Professor, Finance and Real Estate, Academic Department
CFA, FRM, ASA

Tian is an Associate Professor in the Finance and Real Estate Department at Colorado State Univerity in Fort Collins, Colorado. You can read more about his background at biz.colostate.edu.