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VaR in real options analysis

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  • Giuseppe Alesii

Abstract

Cash Flow from operations can be controlled using real options. In this normative paper, we quantify Trigeorgis's intuition [Trigeorgis, L., 1996. Real options: Managerial flexibility and strategy in resource allocation. Cambridge, MA: MIT Press] (p 123), about the risk management properties of real options with respect to downside risk. This result is reached modeling the whole distribution in expanded NPV using a Markov chain Monte Carlo method, computing forward the same expected expanded NPV previously obtained in a backward induction process. A number of original results are derived for an all equity financed firm which exercises optimally the options to wait, to mothball, and to abandon. Cash Flow distribution and CFaR are derived for each epoch in the life of the project. A VaR for the expanded NPV at time 0 is derived. A numerical example studies value and risk in shipping finance.

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  • Giuseppe Alesii, 2005. "VaR in real options analysis," Review of Financial Economics, John Wiley & Sons, vol. 14(3-4), pages 189-208.
    • Handle: RePEc:wly:revfec:v:14:y:2005:i:3-4:p:189-208
    DOI: 10.1016/j.rfe.2004.09.004
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