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Valuing Real Options: Can Risk-Adjusted Discounting Be Made To Work?

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  • James E. Hodder
  • Antonio S. Mello
  • Gordon Sick

Abstract

This paper examines three alternative approaches to valuing real options: (1) the standard option pricing technique using "risk-neutral" probabilities; (2) the use of risk-adjusted discount rates; and (3) discounting certainty-equivalent values with a riskless discount rate. As suggested by the title, a question of particular interest is whether an approach based on risk-adjusted discount rates can be "made to work" for valuing options. The answer is yes. Indeed, the authors show that any of the three approaches will provide a correct valuation if properly employed. 2001 Morgan Stanley.

Suggested Citation

  • James E. Hodder & Antonio S. Mello & Gordon Sick, 2001. "Valuing Real Options: Can Risk-Adjusted Discounting Be Made To Work?," Journal of Applied Corporate Finance, Morgan Stanley, vol. 14(2), pages 90-101.
  • Handle: RePEc:bla:jacrfn:v:14:y:2001:i:2:p:90-101
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    Cited by:

    1. Gordon Sick & Andrea Gamba, 2005. "Some Important Issues Involving Real Options," Working Papers wpn05-02, Warwick Business School, Finance Group.
    2. Schachter, J.A. & Mancarella, P., 2016. "A critical review of Real Options thinking for valuing investment flexibility in Smart Grids and low carbon energy systems," Renewable and Sustainable Energy Reviews, Elsevier, vol. 56(C), pages 261-271.
    3. Yoshifusa Kitabatake, 2002. "Real options analysis of the Minami Alps forest road construction project: new valuation approach to social infrastructure project with sequential unit projects," Environmental Economics and Policy Studies, Springer;Society for Environmental Economics and Policy Studies - SEEPS, vol. 5(4), pages 261-290, December.
    4. Zhu, Lei & Fan, Ying, 2011. "A real options–based CCS investment evaluation model: Case study of China’s power generation sector," Applied Energy, Elsevier, vol. 88(12), pages 4320-4333.
    5. Pendharkar, Parag C., 2010. "Valuing interdependent multi-stage IT investments: A real options approach," European Journal of Operational Research, Elsevier, vol. 201(3), pages 847-859, March.
    6. repec:eee:corfin:v:44:y:2017:i:c:p:99-125 is not listed on IDEAS

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