Modeling of a binomial decision tree for real options

Details

Supervisors

Devolder, Pierre ; Hendrickx, Julien

Faculty

Ecole polytechnique de Louvain

Degree label

Master [120] : ingénieur civil en mathématiques appliquées

Abstract

The conventional valuation methods for investment decisions are mainly based on simplistic methods but real world decisions are confronted more and more with uncertain future events which are not taken into account in the conven- tional calculations. Methods like the net present value and the decision tree analysis undervalue certain investments where some options, like an option to defer or to expand after a certain time, are present. With the real option analysis this additional flexibility is taken into account and can therefore better predict the value of the investment. These options can put a floor on the loss with the arrival of new information when they are exercised. The use of binomial option pricing gives a firm a better valuation of the return of a project in the presence of managerial flexibility in uncertain times. The thesis will cover the advantages and disadvantages as well as the new models, the Cox-Ross-Rubinstein and the Trigeorgis log-transformed methods, which will be tested and there will be a sensitivity analysis to further demonstrate the behavior of the implemented method.