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The Expected Return and Exercise Time of Merton-style Real Options

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Author Info

  • Mark Shackleton

    (Lancaster University, UK)

  • Rafal Wojakowski

    (Lancaster University, UK)

Abstract

We analyse the rate of return and expected exercise time of Merton-style options (1973) employed in many real option situations where the possibility of exercise is both perpetual and American in nature. Using risk-neutral and risk-adjusted pricing techniques, Merton-style options are shown to have an expected return that is a "constant percentage" of the option value and independent of the proximity to the critical exercise boundary. Merton options thus remain at the same point on the Security Market Line, unlike European options whose position and rate of return change dynamically. We also present formulae for the expected time and discounted times to exercise and analyse the dependency of these variables on volatility. Copyright Blackwell Publishers Ltd 2002.

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Bibliographic Info

Article provided by Wiley Blackwell in its journal Journal of Business Finance & Accounting.

Volume (Year): 29 (2002-04)
Issue (Month): 3&4 ()
Pages: 541-555

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Handle: RePEc:bla:jbfnac:v:29:y:2002-04:i:3&4:p:541-555

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0306-686X

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Cited by:
  1. Kit Wong, 2010. "On the neutrality of debt in investment intensity," Annals of Finance, Springer, vol. 6(3), pages 335-356, July.
  2. John Driffill & Turalay Kenc & Martin Sola, 2013. "Real Options With Priced Regime-Switching Risk," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 16(05), pages 1350028-1-1.
  3. Richard Buttimer & Steven Clark & Steven Ott, 2008. "Land Development: Risk, Return and Risk Management," The Journal of Real Estate Finance and Economics, Springer, vol. 36(1), pages 81-102, January.
  4. Giovanni Villani, 2008. "R&D Cooperation in Real Option Game Analysis," Quaderni DSEMS 19-2008, Dipartimento di Scienze Economiche, Matematiche e Statistiche, Universita' di Foggia.

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