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Start-ups Defined as Portfolios of Embedded Options

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  • Pascal BOTTERON

    (Institute of Banking and Finance, HEC-University of Lausanne and Ernst & Young Ltd.)

  • Jean-François CASANOVA

    (Strategic Risk Management)

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    Abstract

    In this paper we show the advantages of staged investments for venture capitalists. We develop an option-pricing model that enables to evaluate the flexibility acquired by a venture capitalist when he stages his investment process. Instead of investing a fixed amount at the beginning of the investment, the venture capitalist proceeds to a staged investment (one first investment and a second investment). The second investment will be triggered by a successful achievement of the first investment. Should the first investment be unsuccessful, the second investment will not be executed. Staging the investment in two phases enables the investor to reduce its uncertainty at the beginning of the project. As it will be demonstrated in the paper, the decision to proceed to the second investment can be modelled as a portfolio of a call option and a binary option.

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    Bibliographic Info

    Paper provided by International Center for Financial Asset Management and Engineering in its series FAME Research Paper Series with number rp85.

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    Date of creation: May 2003
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    Handle: RePEc:fam:rpseri:rp85

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    Keywords: real options; staged investments; structured products; embedded options;

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    1. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November.
    2. 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.
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