Fuzzy pay-off method for real options: The center of gravity approach with application in oilfield abandonment

Abstract

This paper presents the CoG-FPOM, an adaptation of the Fuzzy Pay-Off Method (FPOM). The FPOM is a scenario-based real option valuation method that uses fuzzy numbers as possibility distributions. The paper shows that there are situations in which the original FPOM calculates the real option value to be negative, what is theoretically incorrect. The cause is related to the method used for obtaining a single representative value out of a fuzzy number. Instead of the possibilistic expected value operation used in the original FPOM, the CoG-FPOM uses the center of gravity (CoG) to accomplish the task – a proof of its general validity is presented. An application to calculate the abandonment real option for petroleum producing fields shows that the proposal can be easily used for project valuation under uncertainty.