Abstract
This study proposes to employ a mean-reverting model to evaluate the real options embedded in international railway construction projects. The application of mean-reverting models has usually had the difficulty of defining suitable mean-reverting variables for evaluating railway construction projects. The innovative aspect in this research is the formation and calibration of the mean-reverting models we have proposed, in which underlying variables related to the present value of a railway project normalized by either the length of a railway track or the construction time are assumed to follow stochastic mean-reversion processes. Through an example, we show that this assumption enabled us to have evaluated the abandonment option embedded in the construction project by calibrating the parameters with Euler’s estimation and maximum likelihood estimation.
Highlights
In the past three decades, valuations of capital investment opportunities using real option valuation methods have seen a wide range of developments in areas such as natural resources investments (Tourinho, 1979; Titman, 1985; Brennan and Schwartz, 1985), IT investments (Chen et al, 2007), Capital budgeting (Kensinger, 1987; Trigeorgis, 1986), Agriculture venture investment (Wang and Tang, 2010) and many other fields as such
We have the following possible O-U mean reverting processes corresponding respectively to the parameters estimated in Table 4: ʕJ = 0.6165{0.0776 − J{ʕ + 0.0561ʕx ʕJ = 0.6165{0.3222 − J{ʕ + 0.2329ʕx ʕJ = 0.2115{0.0459 − J{ʕ + 0.0124ʕx ʕJ = 0.2115{0.1906 − J{ʕ + 0.0514ʕx ʕJ = 0.7212{0.3859 − J{ʕ + 0.2715ʕx ʕJ = 0.7245{1.6004 − J{ʕ + 1.1293ʕx. Models applications to another Construction Corporation (CRCC) railway construction project: In order to show the way of using these models, we try to value the abandonment option embedded in another railway project carried out by CRCC
This study employs the meanreverting model to evaluate the real option in the railway construction project
Summary
In the past three decades, valuations of capital investment opportunities using real option valuation methods have seen a wide range of developments in areas such as natural resources investments (Tourinho, 1979; Titman, 1985; Brennan and Schwartz, 1985), IT investments (Chen et al, 2007), Capital budgeting (Kensinger, 1987; Trigeorgis, 1986), Agriculture venture investment (Wang and Tang, 2010) and many other fields as such. We will attempt to examine the effectiveness of the mean-reverting method for real options for railway construction projects. We propose to adopt underlying variables related to the normalized present value of a railway project as dynamic factors which follow mean-reverting processes. The objective of this study is to show that the proposed idea allows us to calibrate the mean-reverting models by using past available construction projects and employing the Euler’s estimations and maximum likelihood estimations. Our research will adopt the mean-reverting Ornstein-Uhlenbeck process for evaluating the real options. Compared with standardized shipping projects, which is securitized and traded as options between major banks, we could assume that two-track railway construction projects can be standardized and follow mean reverting processes.
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