scholarly journals A real option approach for the valuation of switching output flexibility in residential property investment

2018 ◽  
Vol 23 (2) ◽  
pp. 133-151 ◽  
Author(s):  
Kwabena Mintah ◽  
David Higgins ◽  
Judith Callanan
Keyword(s):  
Real Options ◽  
Real Option ◽  
Economic Value ◽  
Management Tool ◽  
Residential Property ◽  
Option Valuation ◽  
Content Type ◽  
Real Option Analysis ◽  
Real Option Valuation ◽  
Mixed Use

Purpose Uncertainties in residential property investment performance require that real estate assets are designed in a flexible manner to respond to impacts of market dynamics. Though estimating the cost of flexibility is straightforward, assessing the economic value of flexibility is not. The purpose of this study is to explore the potential practical application of real option analysis to determine the economic value of a switching output flexibility embedded in a residential property investment in Australia. The study involves the exploration of an optimal strategy for investment in a residential development through real option analysis and valuation of a mixed use investment. Design/methodology/approach The real option valuation model developed by McDonald and Siegel (1986) is adopted for the evaluation because the switching output flexibility is likened to a perpetual American call option with dividend payout. Findings Through real option analysis, the economic value of switching output flexibility of the mixed use building was determined to be higher than the initial upfront costs. Moreover, a payoff of about $4million was determined to be the value of the switching output flexibility, therefore justifying upfront investments in flexibility as an uncertainty and risk management tool. Practical implications This application is an important demonstration of the practical use of options pricing techniques (real options analysis) and delivers further evidence needed to support the adoption of real option valuation in practice. Flexibility can also enhance risks and uncertainty management in residential property investment better than the adjustment of discount rates. Originality/value There is limited evidence on the use of real options techniques for the valuation of switching output flexibility in practice, and this comes as an original application; both the case study and data are all initial applications of switching flexibility in the Australian property market.

scholarly journals Staging option application to residential development: real options approach

2018 ◽  
Vol 11 (1) ◽  
pp. 101-116 ◽  
Author(s):  
Kwabena Mintah ◽  
David Higgins ◽  
Judith Callanan ◽  
Ron Wakefield
Keyword(s):  
Real Options ◽  
Real Option ◽  
Scenario Planning ◽  
Residential Development ◽  
Development Project ◽  
Option Valuation ◽  
Content Type ◽  
Real Option Valuation ◽  
Feasibility Evaluation ◽  
Fuzzy Payoff

Purpose Real option valuation is capable of accounting for uncertainties in residential development projects but still lacks practical adoption due to limited evidence to support application of the theory in practice. The purpose of this paper is to use option valuation to value staging option embedded in residential projects and compare with results from DCF to determine which of the two methods delivers superior results. Design/methodology/approach The fuzzy payoff method (FPOM), a real options model that uses scenario planning approach to generate a range of figures, from which a single-numerical value is computed for decision-making. Findings The results showed that the use of a range of figures was able to represent uncertainties to a higher degree of accuracy than the static DCF. As a result, the FPOM was able to capture about 3 per cent of the value of the project that was missed by the DCF. The staging option offers an opportunity to abandon unprofitable phases of a project, thereby limiting downside losses. Thus, real option models are practically applicable to cases in property sector. Practical implications Residential property developers must consider flexibility in financial feasibility evaluation of development because of the embedded value in uncertain property projects. It is important to account for optionality in financial evaluation of property projects for value maximisation. Originality/value The FPOM has been used for the first time to evaluate a horizontal phasing of a residential development project.

scholarly journals A Fuzzy Pay-Off Method for Real Option Valuation

2009 ◽  
Vol 2009 ◽  
pp. 1-14 ◽  
Author(s):  
Mikael Collan ◽  
Robert Fullér ◽  
József Mezei
Keyword(s):  
Real Option ◽  
Fuzzy Numbers ◽  
Academic Research ◽  
New Method ◽  
Option Valuation ◽  
Modeling And Analysis ◽  
Real Option Analysis ◽  
Valuation Model ◽  
Real Option Valuation ◽  
Different Types

Real option analysis offers interesting insights on the value of assets and on the profitability of investments, which has made real options a growing field of academic research and practical application. Real option valuation is, however, often found to be difficult to understand and to implement due to the quite complex mathematics involved. Recent advances in modeling and analysis methods have made real option valuation easier to understand and to implement. This paper presents a new method (fuzzy pay-off method) for real option valuation using fuzzy numbers that is based on findings from earlier real option valuation methods and from fuzzy real option valuation. The method is intuitive to understand and far less complicated than any previous real option valuation model to date. The paper also presents the use of number of different types of fuzzy numbers with the method and an application of the new method in an industry setting.

scholarly journals Real Option Valuation with Stochastic Interest Rate and Stochastic Volatility

Matematika ◽  
2019 ◽  
Vol 18 (2) ◽  
Author(s):  
Ramdhan Fazrianto Suwarman
Keyword(s):  
Interest Rate ◽  
Real Options ◽  
Stochastic Volatility ◽  
North Sea ◽  
Real Option ◽  
Oil Field ◽  
Stochastic Interest Rate ◽  
Option Valuation ◽  
Real Option Valuation ◽  
Stochastic Interest

Abstract. Real options are one of the most interesting research topics in Finance since 1977 Stewart C. Myers from MIT Sloan School of Management published his pioneering article on this subject in the Journal of Financial Economics. Real options are techniques for supporting capital budgeting decisions that adapt techniques developed for financial securities options. The purpose of using this real option is to capture the options contained in projects that cannot be captured by the discounted cash flow model which operates as a basic framework for almost all financial analyzes. The process of valuing real options will be complemented by the stochastic interest rate and stochastic volatility to better capture the flexibility and volatility of the existing economic and financial situation. The valuation will use a Monte Carlo simulation with the MATLAB programming language on crude oil data from the North Sea oil field. Data were obtained from the thesis of Charlie Grafström and Leo Lundquist with the title "Real Option Valuation vs. DCF Evaluation – An Application to a North Sea oilfield".Keyword: real options, stochastic interest rate model, stochastic volatility model, simulation

Valuing green building certificates as real options

2014 ◽  
Vol 7 (2) ◽  
pp. 181-198 ◽  
Author(s):  
Jussi Vimpari ◽  
Seppo Junnila
Keyword(s):  
Real Options ◽  
Real Option ◽  
Green Building ◽  
Green Buildings ◽  
Content Type ◽  
Real Option Valuation ◽  
Pricing Theory ◽  
Option Pricing Theory ◽  
Industry Professionals ◽  
Real Option Value

Purpose – The purpose of this study is first to evaluate whether real options analysis (ROA) is suitable for valuing green building certificates, and second to calculate the real option value of a green certificate in a typical office building setting. Green buildings are demonstrated as one of the most profitable climate mitigation actions. However, no consensus exists among industry professionals about how green buildings and specifically green building certificates should be valued. Design/methodology/approach – The research design of the study involves a theoretical part and an empirical part. In the theoretical part, option characteristics of green building certificates are identified and a contemporary real option valuation method is proposed for application. In the empirical part, the application is demonstrated in an embedded multiple case study design. Two different building cases (with and without green certificate) with eight independent cash flow valuations by eight industry professionals are used as data set for eight valuation case studies and analyses. Additionally, cross-case analysis is executed for strengthening the analysis. Findings – The paper finds that green certificates have several characteristics similar to real options and supports the idea of using ROA in valuing a green certificate. The paper also explains how option pricing theory and discounted cash flow (DCF) method deal with uncertainty and what shortcomings of DCF could be overcome by ROA. The results show that a mean real option value of 985,000 (or 8.8 per cent premium to the mean property value) was found for a Leadership in Energy and Environmental Design Platinum certificate in the Finnish property market. The main finding of the paper suggests that the contemporary real option valuation methods are appropriate to assess the monetary value and the uncertainty of a green building certificate. Originality/value – This is the first study to argue that option-pricing theory can be used for valuing green building certificates. The identification of the option characteristics of green building certificates and demonstration of the ROA in an empirical case makes questions whether the current mainstream investment analysis approaches are the most suitable methods for valuing green building certificates.

Cash flow estimation for real option analysis using Margrabe's model

2006 ◽  
Vol 56 (2) ◽  
pp. 183-194
Author(s):  
György Andor ◽  
Gábor Bóta
Keyword(s):  
Cash Flow ◽  
Real Option ◽  
Cash Flows ◽  
Option Valuation ◽  
Real Option Analysis ◽  
Flow Estimation ◽  
Capital Budget ◽  
Real Option Valuation ◽  
Exercise Price ◽  
Black Scholes

This paper looks at how the parameters for real option analysis can be extracted from the general capital budget of a project and discusses how the estimated cash flows of a general project can be used for a real option analysis. A project is described where it is possible to stop the business operation in case of predicting a loss for the next year. Our model shows how the cash flow of the period influenced by the option-like decision has to be separated in order to get the exercise price and the price of the underlying asset for real option valuation. Besides providing arguments against the suitability of the general Black-Scholes formula for real option situations, the paper also shows how Margrabe's exchange option valuation formula may be used, and how the volatility as a parameter of this model can be calculated from the data available about the project.

scholarly journals Manager’s Flexibility & Cancellation Option: Insights of a Case Study in the Latin American Oil Industry

2017 ◽  
Vol 1 (3) ◽  
Author(s):  
Arthur Ridolfo Neto ◽  
Marcelo Moreira Russo
Keyword(s):  
Real Options ◽  
Latin American ◽  
Real Option ◽  
Net Present Value ◽  
Option Valuation ◽  
Investment Opportunity ◽  
Gas Field ◽  
The Real ◽  
Real Option Valuation

Purpose: This article focused on the main business insights of the use of Real Options valuation analysis in the eyes of a finance professional. It used a case study of an investment opportunity in the oil and gas field services industry in Latin America to discuss the methodology implementation and its insights. As a secondary objective, it discussed the insights and options embedded in this investment opportunity.Methodology: The investment opportunity was examined using the Real Options Analysis (ROA) framework and the results compared to the traditional methodology of Net Present Value. The valuation technique was performed as if it had been applied at the time the project was approved.Findings: The most important of Real Option valuation is not the results, but how one arrives at them. After the project value is calculated and the project approved or not, the Real Option valuation requires and supports the monitoring of the project. By understanding how the options are created, managers can make better decisions about the project after it was approved.Practical implications: A relevant contribution from the study was the discussion, as a practitioner, of the methodology implementation in a real world corporation. Originality & value: The case study evaluated two types of real options: first, the effect of an option to cancel a contract that was assessed from the perspective of the client contracting the project; and second, the option to abandon and defer, from the perspective of the company that will perform the investment to provide the services. By incorporating the cost of the put option that the company puts forth for the client (cancellation option) it reduces the project value by giving flexibility to its clients.

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