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Option Approach (option + approach)

Distribution by Scientific Domains

Business, Economics, Finance and Accounting	100%

Distribution within Business, Economics, Finance and Accounting

General & Introductory Economics	25%
General & Introductory Finance & Investments	18%

Kinds of Option Approach

real option approach

Selected Abstracts

INVESTMENT IN HOSPITAL CARE TECHNOLOGY UNDER DIFFERENT PURCHASING RULES: A REAL OPTION APPROACH

BULLETIN OF ECONOMIC RESEARCH, Issue 2 2008
Rosella Levaggi
I11; D81 ABSTRACT Quality of health care is the product of several factors as the literature has long recognized. In this paper we focus on the relationship between quality and investment in health technology by analysing the optimal investment decision in a new health care technology of a representative hospital that maximizes its surplus in an uncertain environment. The new technology allows the hospital to increase the quality level of the care provided, but the investment is irreversible. The paper uses the framework of the real option literature to show how the purchaser might influence the quality level by setting a quality-contingent long-term contract with the hospital. The investment in new technology is in fact best incentivated within a long-term contract where the number of treatments reimbursed depends on the level of investment made when the technology is new. In this way, asymmetry of information does not affect the outcome of the contract. In our model in fact the purchaser can verify the level of the investment only at the end of each period but the purchasing rule has an anticipating effect on the decision to invest. [source]

BANK OF AMERICA ROUNDTABLE ON THE REAL OPTIONS APPROACH TO CREATING VALUE IN THE NEW ECONOMY

JOURNAL OF APPLIED CORPORATE FINANCE, Issue 2 2000
Article first published online: 6 APR 200
[source]

Partially Irreversible Investment Decisions and Taxation under Uncertainty: A Real Option Approach

GERMAN ECONOMIC REVIEW, Issue 2 2002
Caren Sureth
The paper applies contingent claims analysis in a real option investment model in order to investigate taxation's influence on investor's decisions under uncertainty. The results show the distortion from realistic-type tax systems, allow to identify a tax-induced paradox in option valuation for specific settings and acknowledge the property of investment neutrality of well-known ,ideal' tax systems in the context of different degrees of irreversibility. Furthermore, it is clarified that the idea of risk-neutral valuation cannot be adopted by the real option approach in general. [source]

On the Determination of Contract Price in Credit Sales Transaction: Exchange Option Approach,

ASIA-PACIFIC JOURNAL OF FINANCIAL STUDIES, Issue 5 2010
Jong Yeon Choi
G32 Abstract Conditions for credit sales transactions vary to a great degree depending upon characteristics of the commodity, the buyer, and the seller. In this paper, we analyzed the buyer's right to return purchased commodities and void his or her financial obligations as an exchange option written by the seller and held by the credit buyer. The value of this exchange option is determined by the value of supplied goods and their volatility, the value of bonds and their volatility, and the correlation between the values of the commodity and the bonds. As a result, this paper was able to derive a model that could explain the impact of: (i) characteristics of the commodities; (ii) characteristics of the buyer; (iii) characteristics of the seller; and (iv) changes in market conditions. Besides the progress stated above, we also derived the necessary condition for both the buyer and the seller to be satisfied in a credit sales transaction. Based on this model, a number of empirical hypotheses were made. [source]

Capital Investment under Alternative Marketing Scenarios in the Hog Industry: A Real Option Approach

CANADIAN JOURNAL OF AGRICULTURAL ECONOMICS, Issue 3 2002
Adam Maung
This paper uses a real option approach to analyze the impact of alternative marketing contracts on the decision to invest in a cooperatively owned hog facility. For the numerical analysis of the impact, this paper uses a simulation method that incorporates early exercise, multiple-state variables, multi-choice decisions and temporal optimality. The results show that the option values that stem from the value of waiting to invest and choosing between alternative marketing methods amounts to 20,36% of the initial investment. Further, having an option to choose an alternative marketing method with different risk structure does add to the value of waiting to invest. Having an option to enter a 15-year marketing contract increases the value of waiting by as much as $117,097 for the pork production example in this paper. Finally, the value of the option to wait is unilaterally lower under a risk-reducing contract scenario than under a spot market alternative. This could explain the explosion in hog production facility investment during the 1990s when prevalence of contract production increased. Les auteurs ont recouru à l'approche du choix véritable pour analyser l'impact d'autres solutions de mise en marché sur la capacité d'investir ou pas dans un élevage de porcs exploitéà la manière d'une coopérative. Aux fins de l'analyse, on s'est servi d'une méthode de simulation intégrant une brève campagne, de multiples variables d'État, des décisions à choix multiple et des conditions optimales dans le temps. Les résultats indiquent que l'existence d'un choix réel permettant à l'exploitant d'attendre avant d'investir et de sélectionner entre plusieurs méthodes de mise en marché représente 20 à 36 pour cent de l'investissement initial. Par ailleurs, le fait d'avoir accès à une autre méthode de mise en marché, à structure de risque différente, ne donne pas plus de valeur à la capacité d'attendre avant de procéder aux investissements. La possibilité de signer une entente de commercialisation de quinze ans accroît la valeur de l'attente de jusqu'à 117,097 $ pour le type d'élevage porcin retenu comme exemple. Enfin, l'existence d'une entente de commercialisation atténuant les risques réduit unilatéralement la valeur de l'option « attente », comparativement à ce qui se produit quand l'éleveur n'a d'autre choix qu'écouler ses bêtes sur le marché au comptant. Ces résultats pourraient expliquer l'explosion des investissements observée dans le secteur du porc au cours des années 90, où la production sous contrat avait sensiblement augmenté. [source]

Managing Risks in Multiple Online Auctions: An Options Approach,

DECISION SCIENCES, Issue 3 2005
Ram Gopal
ABSTRACT The scenario of established business sellers utilizing online auction markets to reach consumers and sell new products is becoming increasingly common. We propose a class of risk management tools, loosely based on the concept of financial options that can be employed by such sellers. While conceptually similar to options in financial markets, we empirically demonstrate that option instruments within auction markets cannot be developed employing similar methodologies, because the fundamental tenets of extant option pricing models do not hold within online auction markets. We provide a framework to analyze the value proposition of options to potential sellers, option-holder behavior implications on auction processes, and seller strategies to write and price options that maximize potential revenues. We then develop an approach that enables a seller to assess the demand for options under different option price and volume scenarios. We compare option prices derived from our approach with those derived from the Black-Scholes model (Black & Scholes, 1973) and discuss the implications of the price differences. Experiments based on actual auction data suggest that options can provide significant benefits under a variety of option-holder behavioral patterns. [source]

Taxation and Investment Decisions: A Real Options Approach

AUSTRALIAN ECONOMIC PAPERS, Issue 1 2001
Elettra Agliardi
The purpose of the paper is to analyse the impact of the tax system on the firm's incentives to invest and disinvest in an uncertain environment. This paper follows the real options approach, which allows us to investigate the value to a firm of waiting to invest and/or disinvest, when payoffs are stochastic and investments partially reversible. The implications for the magnitude and directions of the effects of tax policy are studied; also the case of tax policy uncertainty is examined. [source]

Patents and R&D as Real Options

ECONOMIC NOTES, Issue 1 2004
Eduardo S. Schwartz
This article develops and implements a simulation approach to value patents and patent-protected R&D projects based on the Real Options approach. It takes into account uncertainty in the cost-to-completion of the project, uncertainty in the cash flows to be generated from the project, and the possibility of catastrophic events that could put an end to the effort before it is completed. It also allows for the possibility of abandoning the project when costs turn out to be larger than expected or when estimated cash flows turn out to be smaller than anticipated. This abandonment option represents a very substantial part of the project's value when the project is marginal or/and when uncertainty is large. The model presented can be used to evaluate the effects of regulation on the cost of innovation and the amount on innovative output. The main focus of the article is the pharmaceutical industry. The framework, however, applies just as well to other research-intensive industries such as software or hardware development. (J.E.L.:G31, O22, O32). [source]

Mortgage Terminations, Heterogeneity and the Exercise of Mortgage Options

ECONOMETRICA, Issue 2 2000
Yongheng Deng
As applied to the behavior of homeowners with mortgages, option theory predicts that mortgage prepayment or default will be exercised if the call or put option is ,in the money' by some specific amount. Our analysis: tests the extent to which the option approach can explain default and prepayment behavior; evaluates the practical importance of modeling both options simultaneously; and models the unobserved heterogeneity of borrowers in the home mortgage market. The paper presents a unified model of the competing risks of mortgage termination by prepayment and default, considering the two hazards as dependent competing risks that are estimated jointly. It also accounts for the unobserved heterogeneity among borrowers, and estimates the unobserved heterogeneity simultaneously with the parameters and baseline hazards associated with prepayment and default functions. Our results show that the option model, in its most straightforward version, does a good job of explaining default and prepayment, but it is not enough by itself. The simultaneity of the options is very important empirically in explaining behavior. The results also show that there exists significant heterogeneity among mortgage borrowers. Ignoring this heterogeneity results in serious errors in estimating the prepayment behavior of homeowners. [source]

Partially Irreversible Investment Decisions and Taxation under Uncertainty: A Real Option Approach

Are credit spreads too low or too high?

THE JOURNAL OF FUTURES MARKETS, Issue 12 2009
A hybrid barrier option approach for financial distress
Based on the works of Brockman, P. and Turtle, H. J. (2003) and Giesecke, K. (2004), we propose in this study a hybrid barrier option model to explain observed credit spreads. It is free of problems with the structural model, which underprescribed credit spreads for investment grade corporate bonds and overprescribed the high-yield issues. Unlike the standard barrier option approach, our hybrid model does not imply, for high-yield issues with firms under financial stress, a reduction of credit spreads while firm value actually falls. Our empirical analysis supports that when credit spreads are quoted abnormally higher or rising faster than expected, unexpected changes tend to persist. Otherwise a significant and prompt reversion to long-term equilibrium takes place. This asymmetric pricing phenomenon is validated with a method introduced by Enders, W. and Granger, C. W. J. (1998) and Enders, W. and Siklos, P. L. (2001). The pricing asymmetry could not have been produced by a structural model employing only standard option. But it is consistent with a hybrid barrier option model. Our model characterizes the valuation of debt under financial stress and the asymmetric price pattern better than both the classical structural and the standard barrier option approaches. It can be extended to the study of individual CDS for its better liquidity than individual corporate bonds. This study provides helpful implications especially for the medium and high-yield issues in pricing as well as portfolio diversification. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 29:1161,1189, 2009 [source]

Capital Investment under Alternative Marketing Scenarios in the Hog Industry: A Real Option Approach

Are credit spreads too low or too high?

STRATEGY AND SHAREHOLDER VALUE CREATION: THE REAL OPTIONS FRONTIER

JOURNAL OF APPLIED CORPORATE FINANCE, Issue 2 2000
Martha Amram
The current interest in real options reflects the dramatic increase in the uncertainty of the business environment. Viewed narrowly, the real options approach is the extension of financial option pricing models to the valuation of options on real (that is, nonfinancial) assets. More broadly, the real options approach is a way of thinking that helps managers formulate their strategic options,the future opportunities that are created by today's investments,while considering their likely effect on shareholder value. But if the real options framework promises to link strategy more closely to shareholder value creation, there are some major challenges on the frontier of application. In the first part of this paper, the authors tackle the question, "What is really new about real options, and how does the approach differ from other wellestablished ways to make strategic decisions under uncertainty?" This article provides a specific definition of real options that relies on the ability to track marketpriced risk. Using examples from oil exploration and pharmaceutical drug development, the authors also show how specific features of the industry and the application itself determine the usefulness of the real options approach. The second part of the paper addresses the question: Given the many differences between real and financial options, how should a real options application be framed? The authors examine the use of real options in the valuation of Internet companies to demonstrate the required judgment and tradeoffs in the framing of real options applications. The case of Webvan, an online grocer, is used to illustrate the inter-action between strategy, execution, and valuation. [source]

Real Options Analysis: Where Are the Emperor's Clothes?

JOURNAL OF APPLIED CORPORATE FINANCE, Issue 2 2005
Adam Borison
Once a topic of interest only to finance specialists, real options analysis now receives active, mainstream attention in business schools and industry. This article provides practitioners with a critical review of five well-established real options approaches that are extensively documented in the academic and professional literature. These approaches include the "classic approach" and "revised classic approach" (as proposed by Martha Amram and Nalin Kulatilaka), the "subjective approach" (as proposed by Tim Luehrman), the "MAD Approach" (as proposed by Tom Copeland and Vladimir Antikarov), and the "integrated approach" (as proposed by James Smith and Robert Nau). The article discusses the assumptions, mechanics, and potential range of applications of each approach, along with the results when applied to a simple case involving development of a natural gas field. While the approaches share a focus on investment flexibility and shareholder value, they rely on fundamentally different assumptions, use significantly different techniques, and can produce dramatically different results. Consequently, a great deal of thought must go into selecting and applying them in practice. The revised classic approach appears to be best suited to cases dominated either by "market" risk or "private" risk alone, and where approximate results are acceptable and resources are limited. The integrated approach is best suited to cases with a mix of market and technological risks, and where accuracy and a management roadmap are critical. [source]

Real Options: Meeting the Georgetown Challange

JOURNAL OF APPLIED CORPORATE FINANCE, Issue 2 2005
Thomas E. Copeland
In response to the demand for a single, generally accepted real options methodology, this article proposes a four-step process leading to a practical solution to most applications of real option analysis. The first step is familiar: calculate the standard net present value of the project assuming no managerial flexibility, which results in a value estimate (and a "branch" of a decision tree) for each year of the project's life. The second step estimates the volatility of the value of the project and produces a value tree designed to capture the main sources of uncertainty. Note that the authors focus on the uncertainty about overall project value, which is driven by uncertainty in revenue growth, operating margins, operating leverage, input costs, and technology. The key point here is that, in contrast to many real options approaches, none of these variables taken alone is assumed to be a reliable surrogate for the uncertainty of the project itself. For example, in assessing the option value of a proven oil reserve, the relevant measure of volatility is the volatility not of oil prices, but of the value of the operating entity,that is, the project value without leverage. The third step attempts to capture managerial flexibility using a decision "tree" that illustrates the decisions to be made, their possible outcomes, and their corresponding probabilities. The article illustrate various kinds of applications, including a phased investment in a chemical plant (which is treated as a compound option) and an investment in a peak-load power plant (a switching option with changing variance, which precludes the use of constant risk-neutral probabilities as in standard decision tree analysis). The fourth and final step uses a "no-arbitrage" approach to form a replicating portfolio with the same payouts as the real option. For most corporate investment projects, it is impossible to locate a "twin security" that trades in the market. In the absence of such a security, the conventional NPV of a project (again, without flexibility) is the best candidate for a perfectly correlated underlying asset because it represents management's best estimate of value based on the expected cash flows of the project. [source]