Investment under uncertainty – introduction to real options

Organizational issues:

• In order to pass the course each student has to give a presentation. This presentation may be based on your own work in real options or you can present a paper you have read.
• I will provide you with a paper, or you can find a paper on your own. However, in such a case you have to inform me about it.
• If you want to present your own work, you have to discuss it with me beforehand.
• In your presentation you do not need to summarize the paper, or read it aloud. You should first of all show how real options are used.
• Each presentation should take about 30 minutes.
• By our fourth I want to know who presents what.
• If you cannot be present during the meeting at which you are supposed to give a presentation, you have to inform me in advance. If such a person is unable to present at another meeting, you have to submit a written version of your report in order to pass.
• During first 7 meetings I will show you the real options’ theory and its mathematical fundaments. From the 8^th meeting onwards you will give the presentations and we will discuss them.
• I am checking the list. Each student has to be present at 50% + 1 meetings. If you are absent at more meetings, then you fail the course. The cause of the absence in not important.

Lecture 3

Basic literature:

• Chiang, A.C. (1984), Fundamental Methods of Mathematical Economics, McGraw-Hill, New York

• Dixit, A.K. (1993), The Art of Smooth Pasting, Harwood Academic Publishers.

• Dixit, A.K., R.S. Pindyck (1994), Investment under Uncertainty, Princeton University Press, Princeton, N.J.

• Real Options in Petroleum: http://www.puc-rio.br/marco.ind/main.html

• http://www.real-options.org/

Examples of papers for presentations:

• Belke, A., M. Göcke (2004), Real Options Effects on Employment: Does Exchange Rate Uncertainty Matter for Aggregation?, IZA DP No. 1126

• Boyer, M., P. Lasserre, T. Mariotti, M. Moreaux (2001), Real Options, Preemption, and the Dynamics of Industry Investments, Université du Quebéc á Montréal, Working Paper No. 20-10

• Caballero, R.J., R.S. Pindyck (1996), „Uncertainty, Investment, and Industry Evolution”, International Economic Review, 37, 641-662

• Cassiman, B., M. Ueda (2002), Optimal Project Rejection and New Firm Start-ups, CEPR Discussion Paper No. 3429

• Chi, T. (2000), „Option to acquire or divest a joint venture”, Strategic Management Journal 21, 665-687

• Dixit, A.K. (1993), „Irreversible Investment and Competition Under Uncertainty”, in Capital, Investment, and Development, eds. K. Basu, M. Majumdar, T. Mitra, Cambridge, MA, Basil Blackwell

• Ekern, S. (1988), „An Option Pricing Approach to Evaluating Petroleum Projects”, Energy Economics, 91-99

• Huisman, K., P.M. Kort (1999), Effects of Strategic Interactions on the Option Value of Waiting, University of Tilburg Discussion Paper.

• Kemna, A.G.Z. (1993), „Case Studies on Real Options”, Financial Management, 259-270

• Kogut, B., N. Kulatilaka (1994), „Operating flexibility, global manufacturing, and the option value of a multinational network”, Management Science, 40, 123-139.

• Majd, S., S.C. Myers (1987), „Tax Asymmetries and Corporate Tax Reform", in The Effects of Taxation on Capital Accumulation, ed. M. Feldstein. Chicago: UCP.

• Martin, J.S., A.M. Santomero (1997), „Investment opportunities and corporate demand for lines of credit”, Journal of Banking and Finance, 21, 1331-1350.

• McDonald, R., D. Siegel (1986), „The Value of Waiting to Invest”, Quarterly Journal of Economics, 101, 707-727

• Miller, M., L. Zhang (1996), „Oil price hikes and development triggers in peace and war”, Economic Journal, 106, 445-457.

• Paddock, J.L., D. R. Siegel, J. L. Smith (1988), „Option Valuation of Claims on Real Assets: The Case of Offshore Petroleum Leases”, Quarterly Journal of Economics, 479-508

• Park, S. (1997), Option value of credit lines as an explanation of high credit card rates, Federal Reserve Bank of New York

• Pindyck, R.S. (2005), Sunk Costs and Real Options in Antitrust, NBER Working Paper No. 11430