Evaluating investment opportunities under different model dynamics: Some managerial insights

• Autor(a) principal: Ferreira, Paulo Fernando Marques
• Data de Publicação: 2012
• Tipo de documento: Dissertação
• Idioma: eng
• Título da fonte: Repositório Científico de Acesso Aberto de Portugal (Repositórios Cientìficos)
• Texto Completo: http://hdl.handle.net/10071/6397
• topic: Real Options; Flexibility; Geometric Brownian Motion; Constant elasticity of variance diffusion; Opções reais; Flexibilidade; Movimento Browniano geométrico; Difusão da constante elasticidade da variância

The Net Present Value is the most well known measure of project valuation for managers. However it requires an investment decision made in the moment as well as the cash outflow of the investment. However, a manager has different levels of flexibility in the exercise of his functions that the classic Net Present Value valuation does not take in account. An investment can be delayed to a pre-committed date, can have the decision delayed by a certain or an endlessly period of time, and can be reverted. Despite not applicable to all parameters, the numerical analysis made in this thesis has a pretty straight-forward conclusion, the higher the flexibility a manager can dispose, the value of the project for the manager rises. A project value is not only affected by its parameters and by the flexibility disposed to the manager. The model dynamic in which a project is calculated is also a very important tool for managers to consider. The most used model dynamic to value real options is the Geometric Brownian Motion, which assumes constant volatility. Constant volatility is not a legit assumption to take, since a wide range of assets and markets do not have constant volatility. To overcome this flaw, the Constant Elasticity of Variance diffusion model is considered in this thesis. Numerical analysis made in this thesis proves that a manager is exposed to real options valuation errors by assuming constant volatility.