Real Option Problems Research Articles

Kulatilaka '93: The Case of a Dual Fuel Boiler: A Review, Gauss Codes and Numerical Examples

In this short paper some computational aspects of dynamic programming (DP) applied to the real option problem of the dual fuel boiler in (Kulatilaka, 1993) are examined. A Gauss code has been written, and it is reported in the text, for both pedagogical and practical purposes. As a matter of fact, understanding how the code works helps to delve better into the mechanics of the DP algorithm. On the other hand, the reported code is an hands tool for those who want to apply the (Kulatilaka, 1993) model to real business situations. Since the estimation of the stochastic process driving the state variable of the system is crucial for a good application of the model, four different econometric methods have been applied to the estimation of Ornstein - Uhlenbeck parameters, namely OLS for the (Kulatilaka, 1993) and the (Dixit, Pindyck 1994) specifications, GMM and MLLE for (Roncalli, 1999) approach. Several comparative statics exercises have been performed on real data on oil, coal, natural gas and the boiler characteristics.

Simulation and Numerical Methods in Real Options Valuation

This paper provides an overview of numerical methods and its applicability for solving real option problems. It discusses alternative approaches and shows that both forward and backward induction procedures have a place in real options valuation. A case-project with the option of investing in the future contingent on a stochastic output price is valued using binomial trees, finite differences, and simulation. The Black and Scholes (1973) analytical solution to this problem is used as a benchmark. All four methods provide similar results. The extension of simulation methods to American-Type options is discussed and a solution to Brennan and Schwartz's (1985) classic mine valuation problem is presented. The benefits of this approach, with its better handling of complex uncertainty modeling and path-dependent cash flows, are discussed.

How Effective is Proxy Voting? Information Aggregation and Conflict Resolution in Corporate Voting Contests

This paper analyzes the efficiency of shareholder voting as a mechanism to resolve differences of opinion and conflicts of interest among shareholders. Passing a proxy proposal or electing a dissident slate of directors requires the votes of a number of minority blockholders. If they vote strategically, they behave like one representative shareholder who solves a real option problem and is constrained to observe only a subset of all available information. The decision is improved if shareholders are allowed to communicate freely, but this does not overcome the incentive to misrepresent information in the presence of conflicts of interest. Then trading in a public market improves the allocation if two conditions are met: the voting process is not controlled by insiders and the market aggregates information accurately. Better information aggregation may lead to inferior results in insider controlled firms, and noisy information aggregation in the stock market may be worse than none at all. Announcement returns are better understood as option premia rather than wealth effects since positive announcement returns are consistent with proposals that are expected to reduce shareholder value. Empirical implications link the effectiveness of voting to trading volume and stock price volatility. The direction of stock price changes is not consistently related to the voting outcome or the effectiveness of shareholder voting.