Preprintgreen2006

Monte Carlo Estimation of Project Volatility for Real Options Analysis

50 citations0/0 files storedRePEc: Research Papers in Economics

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Capital Investment and Risk Analysis Stochastic processes and financial applications Financial Reporting and Valuation Research

Abstract

Volatility is a fundamental parameter for option valuation. In particular, real options models require project volatility, which is very hard to estimate accurately because there is usually no historical data for the underlying asset. Several authors have used a method based on Monte Carlo simulation for estimating project volatility. In this paper we analyse the existing procedures for applying the method, concluding that they will lead to an upward bias in the volatility estimate. We propose different procedures that will provide better results, and we also discuss the business consequences of using upwardly biased volatility estimates in real options analysis.

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References

1994Investment Under Uncertainty.2001Valuing American Options by Simulation: A Simple Least-Squares Approach 1993The Nature of Option Interactions and the Valuation of Investments with Multiple Real Options 2002Real options analysis : tools and techniques for valuing strategic investments and decisions 2002MULTI-STAGE CAPITAL INVESTMENT OPPORTUNITIES AS COMPOUND REAL Options 1998Estimating volatility and dividend yield when valuing real options to invest or abandon 1997Investment Analysis of Offshore Concessions in the Netherlands

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