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The Nature of Option Interactions and the Valuation of Investments with Multiple Real Options

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Author Info
Trigeorgis, Lenos
Abstract

This paper deals with the nature of option interactions and the valuation of capital budgeting projects possessing flexibility in the form of multiple real options. It identifies situations where option interactions can be small or large, negative or positive. Interactions generally depend on the type, separation, degree of being and the order of the options involved. The paper illustrates, through a generic example, the importance of properly accounting for interactions among the options to defer, abandon, contract or expand investment, and switch use. It is shown that the incremental value of an additional option, in the presence of other options, is generally less than its value in isolation, and declines as more options are present. Therefore, valuation errors from ignoring a particular option may be small. However, configurations of real options exhibiting precisely the opposite behavior are identified. Comparative statics results confirm that the value of flexibility, despite interactions, manifests familiar option properties.

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Publisher Info
Article provided by Cambridge University Press in its journal Journal of Financial and Quantitative Analysis.

Volume (Year): 28 (1993)
Issue (Month): 01 (March)
Pages: 1-20
Download reference. The following formats are available: HTML (with abstract), plain text (with abstract), BibTeX, RIS (EndNote, RefMan, ProCite), ReDIF
Handle: RePEc:cup:jfinqa:v:28:y:1993:i:01:p:1-20_00

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  1. Giuseppe Pennisi & Pasquale L. Scandizzo, 2006. "Economic Evaluation in the age of Uncertainty," CEIS Research Paper 86, Tor Vergata University, CEIS. [Downloadable!]
  2. James L. Smith & Rex Thompson, 2004. "Managing a Portfolio of Real Options: Sequential Exploration of Dependent Prospects," Working Papers 0403, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research. [Downloadable!]
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  3. Ilhem Kassar & Pierre Lasserre, 2002. "Species Preservation and Biodiversity Value: A Real Options Approach," CIRANO Working Papers 2002s-82, CIRANO. [Downloadable!]
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  4. Li, Yong & James, Barclay & Madhavan, Ravi & Mahoney, Joseph T., 2006. "Real Options: Taking Stock and Looking Ahead," Working Papers 06-0114, University of Illinois at Urbana-Champaign, College of Business. [Downloadable!]
  5. Véronique Bastin & Albert Corhay & Georges Hübner & Pierre-Armand Michel, 2002. "Development path and capital structure of belgian biotechnology firms," Research series 200205-11, National Bank of Belgium. [Downloadable!]
  6. Pedro Godhino & J.P. Costa, 2000. "The Use Of Time And Financial Value In Project Decision Trees - A Specific Model And An Algorithm For Rolling Back The Trees," Computing in Economics and Finance 2000 54, Society for Computational Economics. [Downloadable!]
  7. Towe, Charles & Nickerson, Cynthia & Bockstael, Nancy, 2005. "An Empirical Examination of Real Options and the Timing of Land Conversions," 2005 Annual meeting, July 24-27, Providence, RI 19125, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association). [Downloadable!]
  8. Andrea Gamba & Alberto Micalizzi, 2002. "Product Development and Market Expansion: a Valuation Approach Based on Real Options," Working Papers 1, Università di Verona, Dipartimento di Scienze economiche. [Downloadable!]
  9. Rachel A. Campbell & Roman Kräussl, 2006. "Does Patience Pay? Empirical Testing of the Option to Delay Accepting a Tender Offer in the U.S. Banking Sector," CFS Working Paper Series 2006/32, Center for Financial Studies. [Downloadable!]
  10. Rainer Brosch, 2001. "Portfolio-aspects in real options management," Working Paper Series: Finance and Accounting 66, Department of Finance, Goethe University Frankfurt am Main. [Downloadable!]
  11. Lint, O., 2000. "Retrospective insights from real options in R&D," ECIS Working Papers 00.09, Eindhoven Centre for Innovation Studies, Eindhoven University of Technology. [Downloadable!]
  12. Yu-Lin Huang & Shih-Pei Chou, 2006. "Valuation of the minimum revenue guarantee and the option to abandon in BOT infrastructure projects," Construction Management & Economics, Taylor and Francis Journals, vol. 24(4), pages 379-389, April. [Downloadable!] (restricted)
  13. S. Ping Ho & Liang Y. Liu, 2002. "An option pricing-based model for evaluating the financial viability of privatized infrastructure projects," Construction Management & Economics, Taylor and Francis Journals, vol. 20(2), pages 143-156, March. [Downloadable!] (restricted)
  14. Viju, Crina & Kerr, William A. & Nolan, James, 2006. "Subsidization of the Biofuel Industry: Security vs. Clean Air?," 2006 Annual meeting, July 23-26, Long Beach, CA 21321, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association). [Downloadable!]
  15. Tony Tong & Jing Li, 2008. "Real options and MNE strategies in Asia Pacific," Asia Pacific Journal of Management, Springer, vol. 25(1), pages 153-169, January. [Downloadable!] (restricted)
  16. Matheus R Grasselli & Sebastiano Silla, 2009. "A policyholder's utility indifference valuation model for the guaranteed annuity option," Quantitative Finance Papers 0908.3196, arXiv.org. [Downloadable!]
  17. Dixit, Avinash K. & Pindyck, Robert S. & Massachusetts Institute of Technology. Center for Energy and Environmental Policy Research., 2003. "Expandability, reversibility, and optimal capacity choice," Working papers 97-006WP., Massachusetts Institute of Technology (MIT), Sloan School of Management. [Downloadable!]
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