Real Options Valuation: The Importance of Interest Rate Modelling in Theory and Practice
Springer Science & Business Media, Mar 30, 2006 - Business & Economics - 360 pages
Managerial decision-making during the lifetime of a project can have im portant implications on project handling and its contribution to shareholder value. Traditional capital budgeting methods (in particular methods based on net present value) fail to capture the role of managerial degrees of free dom and therefore tend to lead to a systematic undervaluation of the project. In contrast, the real options approach to investment analysis characterizes decision-making flexibility in terms of (real) option rights which can be eval uated analogously to financial options using contingent-claims pricing tech niques widely used in capital markets. The research carried out by Marcus Schulmerich analyzes real options for n- constant and stochastic interest rates versus constant interest rates. Analyzing stochastic interest rates in the context of real options valuation is of particular relevance given their long time to maturity which makes them more vulnera ble to interest rate risk than short-term financial options. To date, there has not been a comprehensive review of this issue in the academic literature. The fact that interest rates have fiuctuated widely over the recent years further highlights the need for studying this issue.
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0.75 of initial 1.5 simulation scheme 100 simulated short-rate 140 Underlying value American put option binomial tree method Black-Scholes formula cash ﬂow constant risk-free interest constant risk-free rate cost of 110 Cox-Ingersoll-Ross model Cox-Ross Cox-Ross-Rubinstein binomial tree European put option expand investment explicit ﬁnite difference Figure ﬁnite difference methods ﬁrst historical backtesting Ho-Lee model Hull-White models Hull-White one-factor model Hull-White two-factor model implied forward rates inﬂuence initial investment cost initial yield curve investment of 0.2 investment project log-transformed binomial tree mean reversion level modiﬁed option to defer Ornstein-Uhlenbeck process real options pricing real options valuation risk-free interest rate salvage factor 0.75 Schulmerich Section short-rate models simulated short-rate paths speciﬁc standard deviation stochastic interest rate stochastic process stochastic risk-free rate stochastic term structure structure of interest Taylor 1.5 simulation term structure models test situation thesis Trigeorgis 132 Trigeorgis log-transformed binomial U.S. Zero yield Vasicek model