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Practical guide to real options in discrete time II


  • Svetlana Boyarchenko

    (The University of Texas at Austin.)

  • Sergei Levendorskii

    (The University of Texas at Austin)


This paper is an extended version of the paper 'Practical Guide to Real Options in Discrete Time' (, where a general, computationally simple approach to real options in discrete time was suggested. We explicitly formulate conditions of the general theorems for basic types of real options, and explain our method in detail for the case of transition density given by exponential functions on each half-axis. To demonstrate that the discrete time approach can be more analytically tractable than the continuous time one, we consider timing of investment with lags, and a model of gradual capital expansion. We obtain simple formulas for the expected values of capital stock in every time period; in continuous time models, a much more sophisticated technique is needed.

Suggested Citation

  • Svetlana Boyarchenko & Sergei Levendorskii, 2005. "Practical guide to real options in discrete time II," Finance 0501014, EconWPA.
  • Handle: RePEc:wpa:wuwpfi:0501014
    Note: Type of Document - pdf; pages: 28

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    References listed on IDEAS

    1. Peter Carr & Liuren Wu, 2003. "The Finite Moment Log Stable Process and Option Pricing," Journal of Finance, American Finance Association, vol. 58(2), pages 753-778, April.
    2. Abel, Andrew B. & Eberly, Janice C., 1999. "The effects of irreversibility and uncertainty on capital accumulation," Journal of Monetary Economics, Elsevier, vol. 44(3), pages 339-377, December.
    3. Steven J. Davis & John C. Haltiwanger & Scott Schuh, 1998. "Job Creation and Destruction," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262540932, January.
    4. Bar-Ilan, Avner & Strange, William C, 1996. "Investment Lags," American Economic Review, American Economic Association, vol. 86(3), pages 610-622, June.
    5. Svetlana Boyarchenko, 2004. "Irreversible Decisions and Record-Setting News Principles," American Economic Review, American Economic Association, vol. 94(3), pages 557-568, June.
    6. Svetlana Boyarchenko, 2001. "Capital Accumulation under Non-Gaussian Processes and the Marshallian Law," Penn CARESS Working Papers 471ab9dee66c9aa1d3ef23dd9, Penn Economics Department.
    7. Angus Deaton & Guy Laroque, 1992. "On the Behaviour of Commodity Prices," Review of Economic Studies, Oxford University Press, vol. 59(1), pages 1-23.
    8. Thomas F. Cooley & Vincenzo Quadrini, 2001. "Financial Markets and Firm Dynamics," American Economic Review, American Economic Association, vol. 91(5), pages 1286-1310, December.
    9. R. Glenn Hubbard, 1994. "Investment under Uncertainty: Keeping One's Options Open," Journal of Economic Literature, American Economic Association, vol. 32(4), pages 1816-1831, December.
    10. S. I. Boyarchenko & S. Z. Levendorskii, 2002. "Pricing of perpetual Bermudan options," Quantitative Finance, Taylor & Francis Journals, vol. 2(6), pages 432-442.
    11. Seung-Ryong Yang & B. Wade Brorsen, 1992. "Nonlinear Dynamics of Daily Cash Prices," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 74(3), pages 706-715.
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    More about this item


    Real options; embedded options; expected present value operators;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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