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Valuation of R&D Sequential Exchange Options Using Monte Carlo Approach

  • Flavia Cortelezzi

    ()

  • Giovanni Villani

    ()

This article describes a methodology for evaluating R&D investment projects using Monte Carlomethods. R&D projects generally involves multiple phases with or without overlapping. R&D investments are made often in a phased manner, with the commencement of subsequent phase being dependent on the successful completion of the preceding phase, it is known as sequential investment. Moreover, each stage creates an opportunity (option) for subsequent investment. Therefore, R&D projects can be considered as ‘Compound Options' in which investments present uncertainty both in the gross project value and in costs. It is possible to use exchange options to value the R&D investment opportunities. In this paper, we propose to value the European and American Real Compound Exchange options through Monte Carlo simulation. We also provide a set of numerical experiments to provide evidence for the accuracy of the proposed methodology.

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File URL: http://hdl.handle.net/10.1007/s10614-008-9157-z
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Article provided by Society for Computational Economics in its journal Computational Economics.

Volume (Year): 33 (2009)
Issue (Month): 3 (April)
Pages: 209-236

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Handle: RePEc:kap:compec:v:33:y:2009:i:3:p:209-236
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  1. Armada, Manuel Rocha & Kryzanowski, Lawrence & Pereira, Paulo Jorge, 2007. "A modified finite-lived American exchange option methodology applied to real options valuation," Global Finance Journal, Elsevier, vol. 17(3), pages 419-438, March.
  2. Barraquand, Jérôme & Martineau, Didier, 1995. "Numerical Valuation of High Dimensional Multivariate American Securities," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(03), pages 383-405, September.
  3. 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.
  4. Carr, Peter P, 1988. " The Valuation of Sequential Exchange Opportunities," Journal of Finance, American Finance Association, vol. 43(5), pages 1235-56, December.
  5. Broadie, Mark & Glasserman, Paul, 1997. "Pricing American-style securities using simulation," Journal of Economic Dynamics and Control, Elsevier, vol. 21(8-9), pages 1323-1352, June.
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