REAL OPTIONS
in THEORY and PRACTICE
in THEORY and PRACTICE
All rights reserved.
12-week Graduate Course
This course comprises 12 two-hour lectures in a single semester. It is
possible to cover the underlying theory (mainly the material in Chapters 2
and 3) in some depth and still have time to cover calibration without being
rushed. The key is to not spend too much time on Chapters 6-11. The
structure of this part of the book is such that students should be able to
work through much of this material on their own, provided that a few
fundamental examples are covered in class (especially the models in Sections
7.2, 7.4, and 8.2).
Lecture 1 Introduction to real options analysis and the modeling framework:
objective function; modeling risk and time; static versus dynamic decision
making.
Lecture 2 Valuation of single-period cash flows: fundamental asset pricing
formula; special cases (traded asset prices; forwards and futures; CAPM).
Lecture 3 Valuation of multi-period cash flows: backward induction; shortcuts
to valuation; portfolios of cash flows; annuities.
Lecture 4 Valuation of multi-period cash flows (cont.) and combining
valuation and decision making: valuing multi-period cash flows using
backward induction; decision trees; dynamic programming.
Lecture 5 Simple timing options: investment timing; R&D timing.
Lecture 6 Compound timing options: sequential investment; resource
extraction.
Lecture 7 More complicated option structures: time-to-build problem;
production-suspension problem.
Lecture 8 Learning options: modelling information gathering (including Bayes'
theorem); oil exploration.
Lecture 9 Calibrating a tree of prices using historical data: random walk;
mean reversion.
Lecture 10 Calibrating risk-neutral probabilities: CAPM; the relationship
between spot and futures prices.
Lecture 11 Calibration when the state variable is the market value of a
completed project.
Lecture 12 Case studies: forestry management and valuation; developing a
gas field.
possible to cover the underlying theory (mainly the material in Chapters 2
and 3) in some depth and still have time to cover calibration without being
rushed. The key is to not spend too much time on Chapters 6-11. The
structure of this part of the book is such that students should be able to
work through much of this material on their own, provided that a few
fundamental examples are covered in class (especially the models in Sections
7.2, 7.4, and 8.2).
Lecture 1 Introduction to real options analysis and the modeling framework:
objective function; modeling risk and time; static versus dynamic decision
making.
- Reading: Chapters 1-2.
Lecture 2 Valuation of single-period cash flows: fundamental asset pricing
formula; special cases (traded asset prices; forwards and futures; CAPM).
- Reading: Chapter 3.
Lecture 3 Valuation of multi-period cash flows: backward induction; shortcuts
to valuation; portfolios of cash flows; annuities.
- Reading: Chapter 4.
Lecture 4 Valuation of multi-period cash flows (cont.) and combining
valuation and decision making: valuing multi-period cash flows using
backward induction; decision trees; dynamic programming.
- Reading: Chapters 4, 5, and 6.
Lecture 5 Simple timing options: investment timing; R&D timing.
- Reading: Chapter 7 (the models in Sections 7.2 and 7.4 are covered in
class, but the whole chapter should be read in preparation for the
lecture).
Lecture 6 Compound timing options: sequential investment; resource
extraction.
- Reading: Chapter 8 (the models in Sections 8.2 and 8.3 are covered in
class, but the whole chapter should be read in preparation for the
lecture).
Lecture 7 More complicated option structures: time-to-build problem;
production-suspension problem.
- Reading: Chapters 9-10.
Lecture 8 Learning options: modelling information gathering (including Bayes'
theorem); oil exploration.
- Reading: Chapter 11 (the material in Sections 11.2 and 11.4 is covered
in class, but the whole chapter should be read in preparation for the
lecture).
Lecture 9 Calibrating a tree of prices using historical data: random walk;
mean reversion.
- Reading: Section 12.1, Chapter 15.
Lecture 10 Calibrating risk-neutral probabilities: CAPM; the relationship
between spot and futures prices.
- Reading: Section 12.2.
Lecture 11 Calibration when the state variable is the market value of a
completed project.
- Reading: Section 14.2; Chapter 16.
Lecture 12 Case studies: forestry management and valuation; developing a
gas field.
- Reading: Chapter 15 and 16.
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