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Valuing Modularity as a Real Option

Author

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  • Andrea Gamba

    (School of Business, George Washington University, Washington, DC 20052; and Department of Economics, University of Verona, 37129 Verona, Italy)

  • Nicola Fusari

    (University of Lugano, 6900 Lugano, Switzerland; and Swiss Finance Institute, 1211 Geneva, Switzerland)

Abstract

We provide a general valuation approach for capital budgeting decisions involving the modularization in the design of a system. Within the framework developed by Baldwin and Clark (Baldwin, C. Y., K. B. Clark. 2000. Design Rules: The Power of Modularity. MIT Press, Cambridge, MA), we implement a valuation approach using a numerical procedure based on the least-squares Monte Carlo method proposed by Longstaff and Schwartz (Longstaff, F. A., E. S. Schwartz. 2001. Valuing American options by simulation: A simple least-squares approach. Rev. Financial Stud. 14(1) 113-147). The approach is accurate, general, and flexible.

Suggested Citation

  • Andrea Gamba & Nicola Fusari, 2009. "Valuing Modularity as a Real Option," Management Science, INFORMS, vol. 55(11), pages 1877-1896, November.
    • Handle: RePEc:inm:ormnsc:v:55:y:2009:i:11:p:1877-1896
    DOI: 10.1287/mnsc.1090.1070
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    2. Michail Chronopoulos & Verena Hagspiel & Stein-Erik Fleten, 2017. "Stepwise investment and capacity sizing under uncertainty," OR Spectrum: Quantitative Approaches in Management, Springer;Gesellschaft für Operations Research e.V., vol. 39(2), pages 447-472, March.
    3. Pascal Létourneau & Lars Stentoft, 2019. "Bootstrapping the Early Exercise Boundary in the Least-Squares Monte Carlo Method," JRFM, MDPI, vol. 12(4), pages 1-21, December.
    4. Mo, Jianlei & Cui, Lianbiao & Duan, Hongbo, 2021. "Quantifying the implied risk for newly-built coal plant to become stranded asset by carbon pricing," Energy Economics, Elsevier, vol. 99(C).
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    6. Jafarizadeh, Babak, 2012. "Information acquisition as an American option," Energy Economics, Elsevier, vol. 34(3), pages 807-816.
    7. Ritu Agarwal & Amrit Tiwana, 2015. "Editorial—Evolvable Systems: Through the Looking Glass of IS," Information Systems Research, INFORMS, vol. 26(3), pages 473-479, September.
    8. Daniel Gull, 2011. "Valuation of Discount Options in Software License Agreements," Business & Information Systems Engineering: The International Journal of WIRTSCHAFTSINFORMATIK, Springer;Gesellschaft für Informatik e.V. (GI), vol. 3(4), pages 221-230, August.
    9. David A. Broniatowski, 2018. "Building the tower without climbing it: Progress in engineering systems," Systems Engineering, John Wiley & Sons, vol. 21(3), pages 259-281, May.
    10. Amrit Tiwana & Benn Konsynski & Ashley A. Bush, 2010. "Research Commentary ---Platform Evolution: Coevolution of Platform Architecture, Governance, and Environmental Dynamics," Information Systems Research, INFORMS, vol. 21(4), pages 675-687, December.
    11. Trigeorgis, Lenos & Tsekrekos, Andrianos E., 2018. "Real Options in Operations Research: A Review," European Journal of Operational Research, Elsevier, vol. 270(1), pages 1-24.
    12. Suvankar Ghosh & O. Felix Offodile, 2016. "A real options model of phased migration to cellular manufacturing," International Journal of Production Research, Taylor & Francis Journals, vol. 54(3), pages 894-906, February.
    13. David A. Broniatowski, 2017. "Flexibility Due to Abstraction and Decomposition," Systems Engineering, John Wiley & Sons, vol. 20(2), pages 98-117, March.
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    16. Pineiro-Chousa, Juan & Vizcaíno-González, Marcos, 2016. "A quantum derivation of a reputational risk premium," International Review of Financial Analysis, Elsevier, vol. 47(C), pages 304-309.

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    More about this item

    Keywords

    real options; modularity; least-squares Monte Carlo;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G3 - Financial Economics - - Corporate Finance and Governance

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