Standard Article

Calculating Real Option Values

  1. Marco Antonio Guimarães Dias1,2

Published Online: 15 FEB 2011

DOI: 10.1002/9780470400531.eorms0127

Wiley Encyclopedia of Operations Research and Management Science

Wiley Encyclopedia of Operations Research and Management Science

How to Cite

Dias, M. A. G. 2011. Calculating Real Option Values. Wiley Encyclopedia of Operations Research and Management Science. .

Author Information

  1. 1

    PUC-Rio, Department of Industrial Engineering, Rio de Janeiro, Brazil

  2. 2

    Financial Planning, Petrobras, Brazil

Publication History

  1. Published Online: 15 FEB 2011

Abstract

This article presents an overview of real option methodologies for evaluation and decision on capital investments under uncertainty. These methodologies are based on one of the two fundamental ideas: the construction of a risk-free portfolio and the risk-neutral probability measure, both to calculate the present value of options using risk-free discount rate. The article discusses these ideas in discrete- and continuous-time approaches, with methods like binomial lattices, stochastic differential equations, integral method, and Monte Carlo simulation. The strengths and weakness of these methods are discussed in light of applications. The article discusses different types of real options as well as the combination of real options with other disciplines like game theory, decision analysis, and genetic algorithms.

Keywords:

  • real options;
  • investment under uncertainty;
  • options pricing;
  • value of flexibility