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Valuing modularity as a real option

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Author Info

  • Andrea GAMBA

    (Departement of Economics, University of Verona)

  • Nicola FUSARI

    (University of Lugano and Swiss Finance Institute)

Abstract

We provide a general valuation approach for capital budgeting decisions involving the modularization of a system. Within the framework developed by Baldwin and Clark (2000), we implement an approach using a numerical procedure based on the Least Squares Monte Carlo method proposed by Longstaff and Schwartz (2001). The approach is accurate, general and flexible.

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Bibliographic Info

Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 08-20.

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Length: 29 pages
Date of creation: Jan 2008
Date of revision:
Handle: RePEc:chf:rpseri:rp0820

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Web page: http://www.SwissFinanceInstitute.ch
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Related research

Keywords: Real options; Modularity; Least Squares Monte Carlo;

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References

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  1. Gollier, Christian & Proult, David & Thais, Francoise & Walgenwitz, Gilles, 2005. "Choice of nuclear power investments under price uncertainty: Valuing modularity," Energy Economics, Elsevier, vol. 27(4), pages 667-685, July.
  2. Andrea Gamba & Lenos Trigeorgis, 2007. "An Improved Binomial Lattice Method for Multi-Dimensional Options," Applied Mathematical Finance, Taylor & Francis Journals, vol. 14(5), pages 453-475.
  3. Carr, Peter P, 1988. " The Valuation of Sequential Exchange Opportunities," Journal of Finance, American Finance Association, vol. 43(5), pages 1235-56, December.
  4. Geske, Robert, 1979. "The valuation of compound options," Journal of Financial Economics, Elsevier, vol. 7(1), pages 63-81, March.
  5. Manuel Moreno & Javier Navas, 2003. "On the Robustness of Least-Squares Monte Carlo (LSM) for Pricing American Derivatives," Review of Derivatives Research, Springer, vol. 6(2), pages 107-128, May.
  6. Geske, Robert & Johnson, Herb E, 1984. " The American Put Option Valued Analytically," Journal of Finance, American Finance Association, vol. 39(5), pages 1511-24, December.
  7. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 113-47.
  8. Andrea Gamba & Gordon A. Sick & Carmen Aranda León, 2008. "Investment under Uncertainty, Debt and Taxes," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 37(1), pages 31-58, 02.
  9. Paul A. Samuelson, 1973. "Proof That Properly Discounted Present Values of Assets Vibrate Randomly," Bell Journal of Economics, The RAND Corporation, vol. 4(2), pages 369-374, Autumn.
  10. Carliss Y. Baldwin & Kim B. Clark, 2000. "Design Rules, Volume 1: The Power of Modularity," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262024667, January.
  11. Rodrigues, Artur & Armada, Manuel J. Rocha, 2007. "The valuation of modular projects: A real options approach to the value of splitting," Global Finance Journal, Elsevier, vol. 18(2), pages 205-227.
  12. Lars Stentoft, 2004. "Convergence of the Least Squares Monte Carlo Approach to American Option Valuation," Management Science, INFORMS, vol. 50(9), pages 1193-1203, September.
  13. Trigeorgis, Lenos, 1993. "The Nature of Option Interactions and the Valuation of Investments with Multiple Real Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 28(01), pages 1-20, March.
  14. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262100711, January.
  15. Broadie, Mark & Detemple, Jerome, 1996. "American Option Valuation: New Bounds, Approximations, and a Comparison of Existing Methods," Review of Financial Studies, Society for Financial Studies, vol. 9(4), pages 1211-50.
  16. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," University of California at Los Angeles, Anderson Graduate School of Management qt43n1k4jb, Anderson Graduate School of Management, UCLA.
  17. Gamba, Andrea & Tesser, Matteo, 2009. "Structural estimation of real options models," Journal of Economic Dynamics and Control, Elsevier, vol. 33(4), pages 798-816, April.
  18. Breen, Richard, 1991. "The Accelerated Binomial Option Pricing Model," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 26(02), pages 153-164, June.
  19. Martzoukos, Spiros H. & Trigeorgis, Lenos, 2002. "Real (investment) options with multiple sources of rare events," European Journal of Operational Research, Elsevier, vol. 136(3), pages 696-706, February.
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Citations

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Cited by:
  1. Rainer Andergassen & Luigi Sereno, 2012. "Valuation of N-stage Investments Under Jump-Diffusion Processes," Computational Economics, Society for Computational Economics, vol. 39(3), pages 289-313, March.
  2. Brauneis, Alexander & Mestel, Roland & Palan, Stefan, 2013. "Inducing low-carbon investment in the electric power industry through a price floor for emissions trading," Energy Policy, Elsevier, vol. 53(C), pages 190-204.
  3. Jafarizadeh, Babak, 2012. "Information acquisition as an American option," Energy Economics, Elsevier, vol. 34(3), pages 807-816.
  4. Daniel Gull, 2011. "Valuation of Discount Options in Software License Agreements," Business & Information Systems Engineering, Springer, vol. 3(4), pages 221-230, August.

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