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PMA license valuation: A Bayesian learning real options approach

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  • Miller, Luke T.
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    Abstract

    This paper develops a Bayesian learning real option (BLRO) by merging the Bayesian decision-making process with the real options framework. The BLRO approach is then used to value a parts manufacturing approval (PMA) license for an aerospace firm in the maintenance, repair, and overhaul industry. The model combines statistical decision theory with options pricing to evaluate strategic capital expenditures assuming a decision time horizon and posturing costs. Real option attributes are discussed in a decision analytic context and thresholds are identified for improved decision-making. In contrast to other models in the real options literature in which new information is passively introduced during the delay period, our approach encourages active information acquisition and quantifies its impact on the decision.

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    Bibliographic Info

    Article provided by Elsevier in its journal Review of Financial Economics.

    Volume (Year): 19 (2010)
    Issue (Month): 1 (January)
    Pages: 28-37

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    Handle: RePEc:eee:revfin:v:19:y:2010:i:1:p:28-37

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    Web page: http://www.elsevier.com/locate/inca/620170

    Related research

    Keywords: Real options Bayesian decision analysis Valuation;

    References

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    1. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
    2. Merton, Robert C, 1987. " A Simple Model of Capital Market Equilibrium with Incomplete Information," Journal of Finance, American Finance Association, vol. 42(3), pages 483-510, July.
    3. Paddock, James L & Siegel, Daniel R & Smith, James L, 1988. "Option Valuation of Claims on Real Assets: The Case of Offshore Petroleum Leases," The Quarterly Journal of Economics, MIT Press, vol. 103(3), pages 479-508, August.
    4. Arrow, Kenneth J & Fisher, Anthony C, 1974. "Environmental Preservation, Uncertainty, and Irreversibility," The Quarterly Journal of Economics, MIT Press, vol. 88(2), pages 312-19, May.
    5. Smidt, Seymour, 1979. "A Bayesian Analysis of Project Selection and of Post Audit Evaluations," Journal of Finance, American Finance Association, vol. 34(3), pages 675-88, June.
    6. Trigeorgis, Lenos, 1996. "Evaluating leases with complex operating options," European Journal of Operational Research, Elsevier, vol. 91(2), pages 315-329, June.
    7. Grenadier, Steven R., 1995. "Valuing lease contracts A real-options approach," Journal of Financial Economics, Elsevier, vol. 38(3), pages 297-331, July.
    8. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
    9. James C. Van Horne, 1969. "The Analysis of Uncertainty Resolution in Capital Budgeting for new Products," Management Science, INFORMS, vol. 15(8), pages B376-B386, April.
    10. James E. Smith & Robert F. Nau, 1995. "Valuing Risky Projects: Option Pricing Theory and Decision Analysis," Management Science, INFORMS, vol. 41(5), pages 795-816, May.
    11. Constantinides, George M, 1978. "Market Risk Adjustment in Project Valuation," Journal of Finance, American Finance Association, vol. 33(2), pages 603-16, May.
    12. Harold Bierman, Jr. & Warren H. Hausman, 1972. "The Resolution of Investment Uncertainty Through Time," Management Science, INFORMS, vol. 18(12), pages B654-B662, August.
    13. Sundaresan, S.M., 2000. "Continuous-Time Methods in Finance: A Review and an Assessment," Papers 00-03, Columbia - Graduate School of Business.
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