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VALUATION OF EVENT-CONTINGENT OPTIONS

Authors


  • I am grateful to William T. Moore (the former editor), Steve Ott (the referee), Mark Shackleton, Dick Stapleton, Daniel Terfassa, and Sanjay Unni for their suggestions related to this paper. I also wish to thank the participants at the EFMA annual meeting (Athens), the FMA annual meeting (Seattle), the MFS annual meeting (Cyprus), and the International Conference on Real Options (Cyprus) for their comments on previous drafts. A previous version of this article circulated with the title “The Valuation of Options on Multiple Operating Cash Flows.”

Abstract

I study a new class of investment options, event-contingent options. These are options to invest and divest in projects that are dependent on other projects of the same firm or that are conditioned by projects of other firms in its value chain. I construct payoff functions and derive closed-form solutions for the value of options to invest contingent on investment (OICI), options to invest contingent on divestment (OICD), options to divest contingent on divestment (ODCD), and options to divest contingent on investment (ODCI). I also derive analytical comparative statics for these option valuation equations and examine their implications on the firm's wealth. I offer examples of event-contingent options in a global context.

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