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Are Real Options "Real"? Isolating Uncertainty From Risk In Real Options Analysis

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  • LEH-CHYAN SO

    (Department of Quantitative Finance, National Tsing Hua University, Taiwan, 101, Section 2 Kuang Fu Road, Hsinchu, Taiwan)

Abstract

This paper derives an adjusted Black–Scholes pricing formula. In separating risk and uncertainty using the robust control technique, we find that both uncertainty and risk raise management's subjective evaluation of real options. We suggest a simple method to filter the risk of the project and to acquire a more reliable value of real options without the influence of uncertainty. In addition, we propose that an investment opportunity may be postponed inappropriately, as under uncertainty the exercise of investment may be delayed by the project manager. To our knowledge, any similar quantitative methods have not hitherto been mentioned in terms of isolating uncertainty from risk in real options analysis that we consider here.

Suggested Citation

  • Leh-Chyan So, 2014. "Are Real Options "Real"? Isolating Uncertainty From Risk In Real Options Analysis," Annals of Financial Economics (AFE), World Scientific Publishing Co. Pte. Ltd., vol. 9(01), pages 1-18.
    • Handle: RePEc:wsi:afexxx:v:09:y:2014:i:01:n:s2010495214500018
    DOI: 10.1142/S2010495214500018
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    References listed on IDEAS

    as
    1. David Roubaud & André Lapied & Robert Kast, 2010. "Real Options under Choquet-Brownian Ambiguity," Working Papers halshs-00534027, HAL.
    2. Fernández, Pablo, 2002. "Valuing real options: frequently made errors," IESE Research Papers D/455, IESE Business School.
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    Cited by:

    1. Wei-ling Chen & Leh-chyan So, 2014. "Validation of the Merton Distance to the Default Model under Ambiguity," JRFM, MDPI, vol. 7(1), pages 1-15, March.

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    More about this item

    Keywords

    Option to defer; investment opportunity; uncertainty; Black–Scholes pricing formula; volatility; G11; G12; G13;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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