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Option Premiums in Mineral Asset Pricing: Are They Important?

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  • Graham A. Davis

Abstract

Mineral assets consistently trade at market values greater than their discounted cash flow (DCF) values. One explanation is that DCF analysis does not and cannot incorporate the asset value generated by asset management under uncertainty. This paper surveys the attempts to empirically quantify the "option premium" associated with optimal mineral asset management. The option premium appears to explain at most half of the observed gap between DCF value and market value, and adds at most 3 percent to a mineral asset's gross worth. Asset management option premiums therefore have only a second-order impact on mineral asset pricing.

Suggested Citation

  • Graham A. Davis, 1996. "Option Premiums in Mineral Asset Pricing: Are They Important?," Land Economics, University of Wisconsin Press, vol. 72(2), pages 167-186.
    • Handle: RePEc:uwp:landec:v:72:y:1996:i:2:p:167-186
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    Cited by:

    1. Davis, Graham A., 1998. "Estimating Volatility and Dividend Yield When Valuing Real Options to Invest or Abandon," The Quarterly Review of Economics and Finance, Elsevier, vol. 38(3, Part 2), pages 725-754.
    2. Davis, Graham A., 1996. "Real options: Managerial flexibility and strategy in resource allocation : Lenos Trigeorgis The MIT Press, Cambridge, MA, 1996, xiii + 427 pp. (hardcover), ISBN 0-262-20102-X," Resources Policy, Elsevier, vol. 22(3), pages 218-220, September.
    3. Ferdinand E. Banks, 2004. "Beautiful and not So Beautiful Minds: An Introductory Essay on Economic Theory and the Supply of Oil," OPEC Energy Review, Organization of the Petroleum Exporting Countries, vol. 28(1), pages 27-62, March.
    4. Moyen, Nathalie & Slade, Margaret & Uppal, Raman, 1996. "Valuing risk and flexibility : A comparison of methods," Resources Policy, Elsevier, vol. 22(1-2), pages 63-74.
    5. Robert Cairns, 2001. "Capacity Choice and the Theory of the Mine," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 18(1), pages 129-148, January.
    6. Insley, M.C. & Wirjanto, T.S., 2010. "Contrasting two approaches in real options valuation: Contingent claims versus dynamic programming," Journal of Forest Economics, Elsevier, vol. 16(2), pages 157-176, April.
    7. Slade, Margaret E., 2001. "Valuing Managerial Flexibility: An Application of Real-Option Theory to Mining Investments," Journal of Environmental Economics and Management, Elsevier, vol. 41(2), pages 193-233, March.
    8. Matthew Clayton & David Yermack, 1999. "Major League Baseball Player Contracts: An Investigation of the Empirical Properties of Real Options," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-051, New York University, Leonard N. Stern School of Business-.
    9. Kuangyuan Zhang & Richard Olawoyin & Antonio Nieto & Andrew N. Kleit, 2018. "Risk of commodity price, production cost and time to build in resource economics," Environment, Development and Sustainability: A Multidisciplinary Approach to the Theory and Practice of Sustainable Development, Springer, vol. 20(6), pages 2521-2544, December.
    10. Savolainen, Jyrki, 2016. "Real options in metal mining project valuation: Review of literature," Resources Policy, Elsevier, vol. 50(C), pages 49-65.
    11. Garry Twite, 2002. "Gold Prices, Exchange Rates, Gold Stocks and the Gold Premium," Australian Journal of Management, Australian School of Business, vol. 27(2), pages 123-140, December.
    12. Jyrki Savolainen & Ramin Rakhsha & Richard Durham, 2022. "Simulation-based decision-making system for optimal mine production plan selection," Mineral Economics, Springer;Raw Materials Group (RMG);Luleå University of Technology, vol. 35(2), pages 267-281, June.
    13. Liu, Xiaoran & Ronn, Ehud I., 2020. "Using the binomial model for the valuation of real options in computing optimal subsidies for Chinese renewable energy investments," Energy Economics, Elsevier, vol. 87(C).
    14. Mikael Collan & Jyrki Savolainen & Pasi Luukka, 2017. "Investigating the effect of price process selection on the value of a metal mining asset portfolio," Mineral Economics, Springer;Raw Materials Group (RMG);Luleå University of Technology, vol. 30(2), pages 107-115, July.
    15. Smith, James L., 2014. "A parsimonious model of tax avoidance and distortions in petroleum exploration and development," Energy Economics, Elsevier, vol. 43(C), pages 140-157.
    16. Simone Kelly, 2017. "The market premium for the option to close: evidence from Australian gold mining firms," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 57(2), pages 511-531, June.

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