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Options to Choose Among the Most Profitable of Several States in the Physical Realm and the Information Realm

Growing Presence of Real Options in Global Financial Markets

ISBN: 978-1-78714-838-3, eISBN: 978-1-78714-837-6

ISSN: 0196-3821

Publication date: 27 November 2017

Abstract

Option models have provided insight into the value of flexibility to switch from one state to another (such as switching a mine or refinery from operating to closed status). More complex flexible processes offer multiple possibilities for switching states. A fabrication facility, for example, may offer options to shift from the current status to any of several alternatives (reflecting reconfiguration of basic facilities to accommodate different operating processes with different outputs). New algorithms enable practical application of complex option pricing models to flexible facilities, improving analysts’ ability to draw sound conclusions about the effects of flexibility and innovativeness on share value. Such models also apply for options with information items as the underlying assets. Information organizations such as oil exploration and development companies may include options to shift from the current capability to any of several alternatives reflecting added abilities to handle new information sources or apply the organization’s talents in new ways. In the case of either physical or information processing, careful attention to estimating the matrix of correlations among the values of potential alternative states allows explicit integration of financial analysis and strategic analysis – especially the influence of substitutes and the anticipated reactions of competitors, suppliers, and potential new entrants.

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Acknowledgements

Acknowledgments

The authors appreciate Phelim Boyle’s updated, electronic algorithm supplied from the working paper version of Boyle and Tse (1990). In addition, we appreciate the updated, electronic version of the multivariate normal subroutine MULNOR supplied by Mark Schervish. We thank the participants in the 31st European Working Group on Financial Modeling for their helpful comments, especially Robert Tompkins.

Citation

Chen, A.H., Conover, J.A. and Kensinger, J.W. (2017), "Options to Choose Among the Most Profitable of Several States in the Physical Realm and the Information Realm ", Growing Presence of Real Options in Global Financial Markets (Research in Finance, Vol. 33), Emerald Publishing Limited, Bingley, pp. 105-121. https://doi.org/10.1108/S0196-382120170000033006

Publisher

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Emerald Publishing Limited

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