A real option approach for investment opportunity valuation

Na Song, Yue Xie, Wai Ki Ching, Tak Kuen Siu

Research output: Contribution to journalArticlepeer-review

2 Citations (Scopus)

Abstract

In this paper, the valuation of an investment opportunity in a high-tech corporation using real option theory and modern capital budgeting is studied. Some key characteristics such as high-risk, multi-stage and technology life cycle of a high-tech project are considered in the proposed model. Since a real option is usually not tradable in the market, an actuarial approach is adopted in our study. We employ an irreversible regime-switching Markov chain to model the multi-stage and technology life cycle of the project in the high-tech industry. The valuation of captured real option can be formulated as the valuation of an American option with time-dependent strike price. For the purpose of practical implementation, a novel lattice-based method is developed to value the American option. Numerical examples are given to illustrate the proposed models and methods.

Original languageEnglish
Pages (from-to)1213-1235
Number of pages23
JournalJournal of Industrial and Management Optimization
Volume13
Issue number3
DOIs
Publication statusPublished - 1 Jul 2017

Keywords

  • real option
  • trinomial tree method
  • regime switching
  • high-tech industry

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