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A Tutorial for Modeling Real Options Lattices from Project Cash Flows

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  • Naielly Lopes Marques
  • Carlos de Lamare Bastian-Pinto
  • Luiz Eduardo Teixeira Brandão

Abstract

Context: several methods for evaluating real options have been extensively studied and published. But recombining binomial trees, known as lattices, are perhaps one of the most practical and intuitive approaches to model uncertainty and price project managerial flexibilities for real options applications. Although the Cox, Ross, and Rubinstein (1979) lattice model is simple to implement for financial options, modeling real options lattices requires a different approach such as the one proposed by Copeland and Antikarov (2001), which considers project cash flows as dividends in the lattice model. Objective: in this tutorial, we propose a code in an open-source software with intuitive guidelines to help researchers and practitioners model real options lattices from project cash flows. Method: our code considers the correct project’s volatility estimation, dividend yield modeling, and lattice building. Results: the results show how real options can affect the value of projects. Conclusions: as a contribution, this tutorial provides a simple mechanism for analyzing investment opportunities in projects that have uncertainty and flexibility.

Suggested Citation

  • Naielly Lopes Marques & Carlos de Lamare Bastian-Pinto & Luiz Eduardo Teixeira Brandão, 2021. "A Tutorial for Modeling Real Options Lattices from Project Cash Flows," RAC - Revista de Administração Contemporânea (Journal of Contemporary Administration), ANPAD - Associação Nacional de Pós-Graduação e Pesquisa em Administração, vol. 25(1), pages 200093-2000.
    • Handle: RePEc:abg:anprac:v:25:y:2021:i:1:1419
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    References listed on IDEAS

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    1. E. Brandão, Luiz & Dyer, James S. & Hahn, Warren J., 2012. "Volatility estimation for stochastic project value models," European Journal of Operational Research, Elsevier, vol. 220(3), pages 642-648.
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    4. Luiz Brandão & James Dyer, 2005. "Decision Analysis and Real Options: A Discrete Time Approach to Real Option Valuation," Annals of Operations Research, Springer, vol. 135(1), pages 21-39, March.
    5. Michael Garvin & Charles Cheah, 2004. "Valuation techniques for infrastructure investment decisions," Construction Management and Economics, Taylor & Francis Journals, vol. 22(4), pages 373-383.
    6. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
    7. K.C. Iyer & Mohammed Sagheer, 2011. "A real options based traffic risk mitigation model for build-operate-transfer highway projects in India," Construction Management and Economics, Taylor & Francis Journals, vol. 29(8), pages 771-779, June.
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    1. Anna Carolina Martins & Marcelo de Carvalho Pereira & Roberto Pasqualino, 2023. "Renewable Electricity Transition: A Case for Evaluating Infrastructure Investments through Real Options Analysis in Brazil," Sustainability, MDPI, vol. 15(13), pages 1-24, July.

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