Abstract

In 1973, Black, Scholes and Merton published two path-breaking papers on rational pricing of financial options, the right, but not the obligation, to buy or sell a stock in the future at a given price. This new approach to the evaluation of financial projects vividly inspired the academic community: over eleven thousands papers have been published on Real Options so far. Yet, thirty-five years after the publication of the first paper, Real Options have penetrated the decision-making processes of large corporations very slowly. Although the general concept of real options is clear, their specific benefits for individual investment decisions are not. Options are still an obscure mathematical tool and the partial differential equation at the core of the option pricing model leaves management with a blank face. The complexity of the stochastic calculus is preventing practitioners from seeing the new decision space created by Real Options and from moving inside this space at ease. This paper reviews the entire development of Real Options research, taking a completely new direction inspired by the unique goal of achieving relevance in management's eyes. The graphical representation of the Ito's lemma, the partial differential equation central to the Black and Scholes pricing model, would help practitioners to visually capture the essence of Real Option thinking. How different would the development of real Options have been if it had originally been designed as a video game?

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