using real option analysis for highly uncertain technology investments the case of wind energy technology this study examines the feasibility of using a theoretical model and empirical analysis methods to value renewable energy re investment from perspective of real option analysis roa based on use of a roa approach the re value is evaluated with respect to its ability to conform to the main sensitivity analysis of re investment as well as an empirical method devised to value re investment by using actual data the economic intuitiveness underlying the decision making process for re investment is elucidated while empirical analysis is performed to demonstrate the effectiveness of the options value embedded in current development planning in taiwan for wind energy in addition to revealing the advantages of re development when considering real option analytical results indicate that roa is a highly effective means of quantifying how investment planning uncertainty including managerial flexibility influences re development besides evaluating the value of current re investment this study demonstrates that results of the theoretical model empirical analysis and sensitivity analysis correlate well with each other restated the value of developing re increases when increasing the underlying price time to maturity risk free rate and volatility conversely the value of developing re decreases when increasing the exercise price

modelling short and long term risks in power markets empirical evidence from nord pool in this paper we propose a three factor spike model that accounts for different speeds of mean reversion between normal and spiky shocks in the scandinavian power market in this model both short and long run factors are unobservable and are hence estimated as latent variables using the kalman filter the proposed model has several advantages first it seems to capture in a parsimonious way the most important risks that practitioners face in the market such as spike risk short term risk and long term risk second it explains the seasonal risk premium observed in the market and improves the fit between theoretical and observed forward prices particularly for long dated forward contracts finally closed form solutions for forward contracts derived from the model are consistent with the fact that the correlation between contracts of different maturities is imperfect the resulting model is very promising providing a very useful policy analysis and financial engineering tool to market participants for risk management and derivative pricing particularly for long dated contracts

analytical upper bounds for american option prices american options require numerical methods namely lattice models to provide accurate price estimates the computations can become expensive when more than one state variable is involved analytical upper bounds can therefore provide a useful guideline for how high american values can reach in this paper we derive analytical closed form upper bounds for american option prices under stochastic interest rates stochastic volatility and jumps where american option prices are difficult to compute with accuracy in a stochastic volatility model heston 1993 and scott 1997 that has two random factors we demonstrate that the upper bound only takes a very small fraction of the time that the american option needs to compute

analytical solution for an investment problem under uncertainties with shocks abstract we derive the optimal investment decision in a project where both demand and investment cost are stochastic processes eventually subject to shocks we extend the approach used in dixit and pindyck 1994 to deal with two sources of uncertainty and we assume that the underlying processes are jump diffusion processes assuming certain conditions on the parameters we are able to derive a closed expression for the value of the firm finally we present comparative statics for the investment threshold with respect to the relevant parameters

development effectiveness what have we learnt we suggest that the poverty efficiency aid allocation is merely a benchmark guide if a donor lacks other information about the country and also the power to change or prevail over government preferences we argue that in most circumstances donors have only limited scope for the latter and that while high aid dependence may reduce the fungibility problem and the use of ngos can by pass it altogether such circumstances are not very common hence the main reasons for departing from the benchmark are when the donor has additional information about likely poverty impact or if poverty reduction is not the objective

a model of delegated project choice we present a model in which a principal delegates the choice of project to an agent with different preferences the principal determines the set of projects from which the agent may choose the principal can verify the characteristics of the project chosen by the agent but does not know which other projects are available to the agent two frameworks are considered i a static setting in which the collection of available projects is exogenous to the agent but uncertain and ii a dynamic setting in which the agent searches for projects

factorization of european and american option prices under complete and incomplete markets abstract in a standard option pricing model with continuous trading and diffusion processes this paper shows that the price of one european style option can be factorized into two intuitive components one robust x 0 which is priced by arbitrage and a second 0 which depends on a risk orthogonal to the traded securities this result implies the following 1 in an incomplete market these parts represent the price of a hedging portfolio which is unique and a premium which depends only on the risk premiums associated with the residual risk respectively 2 in a complete market it allows factoring the contribution of the different sources of risk to the final option price for example in a stochastic volatility model we can quantify the impact on the option price of volatility risk relative to market risk 0 and x 0 respectively hence certain misspricings in option markets can be directly related to the premium 0 3 moreover these results extend to american securities which have a third component an additional early exercise premium

investment uncertainty and liquidity we analyze the dynamic investment decision of a firm subject to an endogenous financing constraint the threat of future funding shortfalls lowers the value of the firm s timing options and encourages acceleration of investment beyond the first best optimal level as well as highlighting another way by which capital market frictions can distort investment behavior this result implies that 1 the sensitivity of investment to cash flow can be greatest for high liquidity firms and 2 greater uncertainty has an ambiguous effect on investment

optimizing the level of renewable electric r d expenditures using real options analysis abstract one of the primary objectives of the united states federal non hydro renewable electric r d program is to promote the development of technologies that have the potential to provide consumers with stable and secure energy supplies in order to quantify the benefits provided by continued federal renewable electric r d this paper uses real option pricing techniques to estimate the value of renewable electric technologies in the face of uncertain fossil fuel prices within the real options analysis framework the current value of expected future supply from renewable electric technologies net of federal r d expenditures is estimated to be 30 6 billion of this value 86 can be attributed to past federal r d efforts and 14 can be attributed to future federal r d efforts assuming continued federal r d funding at 300 million yr in addition real options analysis shows that the value of renewable electric technologies increases as current and future r d funding levels increase this indicates that the current level of federal renewable electric r d funding is sub optimal

real options analysis of investment in solar vs wind energy diversification strategies under uncertain prices and costs in this paper we study a community or firm considering to diversify its investment in two distinct renewable energy technologies namely wind and solar pv electricity we assume technological learning curves as a function of cumulative capital investment a real options approach is applied as it takes into account uncertainty about prices and learning as well as irreversibility associated with investment decisions we investigate three different cases dealing with uncertainty about future electricity prices and uncertainty about the speed with which learning drives the costs of wind and solar electricity down we assess the minimum threshold for the stochastic price and the maximum electricity production cost that makes it optimal for the firm to invest in the two technologies the results show that the learning rate affects the option to invest in but reducing critical threshold for exercising it the greater the amount of capital invested the more learning stimulates earlier exercising of the option to invest the firm will then anticipate the option to invest and exercise it for lower critical threshold values if all capital is invested in one technology if capital investment is diversified the option should be exercised at a higher critical threshold more uncertainty in energy prices or technology costs postpones the option to invest although investing in both solar and wind may be profitable under particular conditions of price and cost uncertainty the theoretically optimal strategy is generally investing in only one technology that is solar or wind depending on their relative initial costs and learning rates this suggests that the practice in most countries of diversifying renewable energy may reflect a mistaken strategy

observability and the payback criterion among the enigmas of corporate finance theory that have received little attention is the puzzling use of the payback method as a capital budgeting tool although the payback method has many drawbacks it is widely used in industry see klammer 1972 fremgren 1973 schall sundem and geijsback 1978 1 gordon 1955 attempted to explain this anomaly by observing that the inverse of the payback period is an approximation for the internal rate of return but as sarnat and levy 1969 point out the accuracy of the approximation depends on the life of the project and its irr for low values of irr the inverse of payback is a very poor approximation moreover it is difficult to believe that corporations that use complex and sophisticated technologies need a rule of thumb to approximate something as simple to compute as the irr in fact empirical evidence shows that most firms compute both the irr and the payback period see schall the payback criterion continues to be widely used in industry although there is little support for it among the academicians this paper attempts to find an economic rationale for it by using an incentive model with asymmetric information it argues that when the managers possess private information regarding projects selected for implementation it is in their interest to choose ceteris paribus projects that pay back faster since manager s wages depend on output because their productivity is unknown by choosing projects that pay back fast they hope to improve their reputations i wish to thank milton harris and an anonymous referee for their helpful suggestions while i retain the responsibility for any remaining errors 1 it has been found that payback is rarely used as a primary capital budgeting method it is used as a secondary criterion to a discounted cash flow method such as npv net present value or irr internal rate of return

static hedging of exotic options this paper develops static hedges for several exotic options using standard options the method relies on a relationship between european puts and calls with different strike prices the analysis allows for constant volatility or for volatility smiles or frowns

capital budgeting and delegation abstract as part of our ongoing research into capital budgeting processes as responses to decentralized information and incentive problems we focus in this paper on when a level of a managerial hierarchy will delegate the allocation of capital across projects and time to the level below it in our model delegation is a way to save on costly investigation of proposed projects therefore it is more extensive the larger are the costs of such investigations this delegation takes advantage of the fact that the lower level manager s preferences are assumed to be similar though not identical to those of the higher level

internal capital markets and the competition for corporate resources this article examines the role of corporate headquarters in allocating scarce resources to competing projects in an internal capital market unlike a bank headquarters has control rights that enable it to engage in winner picking the practice of actively shifting funds from one project to another by doing a good job in the winner picking dimension headquarters can create value even when it cannot help at all to relax overall firm wide credit constraints the model implies that internal capital markets may sometimes function more efficiently when headquarters oversees a small and focused set of projects this article analyzes the process by which internal capital markets channel limited resources to different uses inside a company in so doing it seeks to address two related sets of questions first what is the fundamental economic rationale for creating an internal capital market that is under what circumstances can it make sense to combine several technologically distinct projects under one roof and have them seek funding from corporate headquarters as opposed to setting them up as stand alone companies that each raise external financing on their own second given this rationale what is the optimal size and scope of an internal capital market should headquarters be involved in funding a large number of projects or just a few and should these projects be unrelated to one another or in similar lines of business the answers to both sets of questions flow from the insight that in a credit constrained setting where not all positive npv projects can be financed headquarters can create value by actively reallocating scarce funds across projects for example the cash flow generated by one division s activities may be taken and spent on investment in another division where the returns are higher or alternatively one division s assets may be used as collateral to raise financing that is then diverted to the other division simply put individual projects must compete for the scarce funds and headquarters job is to pick the winners and losers in this competition

capital budgeting in multidivision firms information agency and incentives author s bernardo antonio e cai hongbin luo jiang abstract we consider a firm with two investment projects divisions each run by a manager who can provide i unverifiable information about the quality of either or both projects and ii unverifiable access to valuable resources that can enhance the cash flows of either or both projects we then examine the extent to which capital allocation and managerial compensation schemes can be designed jointly to mitigate the information and incentive problems within the firm we find that the firm underinvests in capital in both projects relative to the first best level optimal managerial profit sharing increases in the quality of both projects and managers underinvest resources in both projects interestingly the underinvestment problem in one project is less severe when the other project is higher quality this effect will be stronger when the moral hazard problem is more acute and project returns are more highly correlated we also predict that multi division firms will invest more less than single division firms when other divisions in the firm perform well poorly

renewable energy policy evaluation using real option model the case of taiwan abstract this study presents a policy benefit evaluation model that integrates cost efficiency curve information on renewable power generation technologies into real options analysis roa methods the proposed model evaluates quantitatively the policy value provided by developing renewable energy re in the face of uncertain fossil fuel prices and re policy related factors the economic intuition underlying the policy making process is elucidated while empirical analysis illustrates the option value embedded in the current development policy in taiwan for wind power in addition to revealing the benefits that re development provides when considering real options analytical results indicate that roa is a highly effective means of quantifying how policy planning uncertainty including managerial flexibility influences re development in addition to assessing the policy value of current re development policy this study also compares policy values in terms of internalized external costs and varying feed in tariff fit simulation results demonstrate that the re development policy with internalized co2 emission costs is appropriate policy planning from sustainability point of view furthermore relationship between varying fit and policy values can be shown quantitatively and appropriate fit level could be determined accordingly

the analytic valuation of american options no analytic solutions exists for the valuation of american options written on futures contracts and foreign currencies for which early exercise may be optimal this article formulates the american option valuation problem in economically and mathematically meaningful ways this enables us to derive valuation formulas for american options the properties associated with the optimal exercise boundary are examined and a numerical technique to implement the valuation formulas is presented article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

time to build option value and investment decisions a comment abstract we correct the analysis of the model of time to build in majd and pindyck 1987 journal of financial economics 18 7 27 for the omission of an essential optimality condition our analysis reveals an additional insight long times to build reduce the effects of increased project value volatility i e higher investment thresholds in comparison to standard real option models of investment under uncertainty where investment is instantaneous thus a naive npv rule can sometimes be an appropriate initial guide to investment

the sensitivity of american options to suboptimal exercise strategies the value of american options depends on the exercise policy followed by option holders market frictions risk aversion or a misspecified model for example can result in suboptimal behavior we study the sensitivity of american options to suboptimal exercise strategies we show that this measure is given by the gamma of the american option at the optimal exercise boundary more precisely if b is the optimal exercise price but exercise is either brought forward when or delayed until a price b has been reached the cost of suboptimal exercise is given by b b b 2 where b denotes the american option gamma therefore the cost of suboptimal exercise is second order in the bias of the exercise policy and depends on gamma this result provides new insights on american options

compound real options valuation of renewable energy projects the case of a wind farm in serbia abstract renewable energy sources have become a very important issue due to environmental and sustainability concerns in addition most renewable energy electricity generation res e projects are characterized by considerable uncertainty and sequential decision making these projects net present value npv is very often close to zero which renders them a good candidate for the application of real options valuation methodology of investment project appraisal this paper examines the real options valuation of a potential onshore wind farm project in serbia the binomial tree model spans a 15 year period consisting of a 2 year investment period and a 13 year operating period the first 12 years of which are protected by feed in tariffs according to local renewable energy regulations the authors examine a multi phased compound nested path dependent real option consisting of mutually exclusive options a sequential option to invest as well as expand repower contract and abandon options volatility which is calculated by means of a monte carlo simulation according to the logarithmic present value returns approach shows predominant sensitivity to the capacity factor simulated with the rescaled weibull s probability distribution the final binomial tree results show that the proposed sequence of options increases project value by transforming higher risk and lower return in the initial discounted cash flow model to lower risk and higher return in the ro model this paper contributes to the existing literature in at least two ways it presents in depth analysis of the real option application to the res e project and provides decision makers with sophisticated tool for improving strategic thinking capital budgeting and decision making processes

why the npv criterion does not maximize npv this article presents a theory of capital allocation that shows how the use of net present value npv as an investment criterion leads to inefficient capital budgeting outcomes and how this criterion may be dominated by other capital budgeting criteria like the internal rate of return and the profitability index the essence of our theory is rooted in the mainstream paradigm of corporate finance while firms use npv to measure the addition to firm value from prospective projects classical informational and agency considerations prevent it from implementing the optimal capital budgeting outcome our theory also identifies conditions when alternative criteria should be used finally we characterize when direct monitoring through capital budgeting dominates compensation contracts in alleviating the agency problem copyright 2004 oxford university press

a real option model for renewable energy policy evaluation with application to solar pv power generation in china abstract this study proposes a policy evaluation model from the perspective of government and investors the proposed model which integrates american option method and two factor learning curve method can be used to evaluate the unit decision value and save path rate for renewable energy development and examine the existence of balance point of interest several uncertain factors including non renewable energy cost carbon price renewable energy cost and price subsidy are all considered in this model the model has been applied to evaluate the solar photovoltaic pv power generation in china our empirical results show that real option analysis roa is more effective than net present value analysis npv when handling uncertainty under current level of subsidy the government would suffer loss and the investors could benefit so that it is difficult to achieve the balance of interest during the planning period with the reduction of subsidy rate they can achieve the balance of interest

application of the modified tobin s q to an uncertain energy saving project with the real options concept abstract this paper is to develop a modified tobin s q evaluation method which successfully combines the evaluation criteria of the traditional tobin s q and the real options this study provides flexible thinking for decision making criteria that is it clearly provides decision makers with a reference in choosing enter or exit strategies such as quantitative indicators references the proposed model introduces two variables stochastic process in continuous time and explores the impact of the occurrence of unexpected events on the project value so that it can more authentically response to the project value the studied issue deals with the firms that have not established energy saving equipment yet it attempts to figure out the optimal timing to adopt an energy saving investment project when it is beneficial and the optimal timing to terminate it when the continuous operation of that business is unprofitable the future discounted benefit cost ratio q follows the geometric brownian motion with the poisson jump process and the replacement of investment equipment except for the evaluation of energy saving equipment investment project the proposed model can be applied to other related project evaluation issues such as energy saving co 2 emission reduction or general investment projects

a real options model for renewable energy investment with application to solar photovoltaic power generation in china this paper proposes a real options model for evaluating renewable energy investment by considering uncertain factors such as co2 price non renewable energy cost investment cost and market price of electricity a phase out mechanism is built into the model to reflect the long term changes of subsidy policy we apply the proposed model to empirically evaluate the investment value and optimal timing for solar photovoltaic power generation in china our empirical results show that the current investment environment in china may not be able to attract immediate investment while the development of carbon market helps advance the optimal investment time a sensitivity analysis is conducted to investigate the dynamics of investment value and optimal timing under the changes of unit generating capacity subsidy level market price of electricity co2 price and investment cost it is found that the high investment cost and the volatility of electricity and co2 prices are not conducive to attract immediate investment instead increasing the level of subsidy promoting technological progress and maintaining the stability of market are useful to stimulate investment

are there negative returns to aid the world bank report assessing aid assumes that an inflow of aid above a certain level starts to have negative effects in this analysis we empirically test this assumption we find evidence for negative returns to aid at high levels of aid inflows however the results are sensitive to both the countries included in the sample and model specification moreover the turning point above which aid starts to have a negative effect on growth seems to be much higher than assumed in the background calculations for assessing aid

option bounds in discrete time extensions and the pricing of the american put in a recent paper perrakis and ryan 1984 upper and lower bounds on european option prices were derived in discrete time these bounds were based on an extension of the discrete time derivation of black scholes pricing first presented in the work of black and scholes 1973 the bounds are functions of the stock and exercise prices the riskless rate of interest the time to maturity and the entire distribution of stock returns in other words they need more information than black scholes for their computation and the derived results are weaker on the other hand they are significantly more general in their assumptions insofar as they do not rely on the continuous time riskless hedge of the original black scholes derivations or on the assumption of a binomial distribution of stock returns used in cox ross and rubinstein 1979 and rendleman and bartter 1979 for this reason they are likely to be particularly useful in valuing options on assets for which the black scholes methodology is clearly this paper generalizes and tightens the discrete time bounds for european options and develops similar bounds for american puts the stock return has a distribution with a finite range and is subject to the restriction that the stock be nonnegative beta the bounds are derived from arbitrage portfolios using the stock the option and the riskless asset they converge to the previous ones when the range coincides with the nonnegative real line and they both become equal to the binomial option model under a two state stock return upper and lower bounds for the american put are derived recursively by the same method with arbitrage portfolios involving the stock the riskless asset and american and european puts an example is provided with a trinomial return distribution part of this research was done while i was a visiting professor 1983 84 ecole superieure de commerce et d administration des entreprises reims france i wish to thank peter ryan albert madansky and a referee of this journal for helpful advice and comment while retaining all responsibility for any remaining errors or omissions 1 note however that this is also true of other blackscholes generalizations such as merton 1976

the saga of the american put abstract the american put is one of the oldest problems in mathematical finance we review the development of the relevant literature over the last 40 years today the mainstream computational problems have been solved satisfactorily and the target of research is shifting towards the development of further insights into the value of timing investment decisions

enhancing renewable and sustainable energy development based on an options based policy evaluation framework case study of wind energy technology in taiwan global warming and climate change have shifted the focus of industrial development towards low carbon renewable energy re as evidence by global efforts to develop re based sustainable energy policies however the generally cost ineffective nature of re investments explains continued governmental subsidies and draft assistance measures to encourage related industrial development reduce research and development r d costs and increase innovativeness besides measures to accelerate supply and reduced demand for energy sustainable energy policies must enact thoroughly planned legal and regulatory mechanisms notable examples of establishing a legal basis for a low carbon society in taiwan include the energy management act renewable energy development bill greenhouse gas reduction act draft and energy tax act draft however such legislative efforts occasionally conflict or compete with each other warranting further integration additionally re technologies are characterized by high r d costs long term planning and high investment risks therefore based on global trends in wind power development and related policy planning this study analyzes the feasibility of implementing management strategies in the development process and the correlations between such strategies additionally the achievements polices functions mechanisms promotion measures and future plans for related renewable and sustainable energy laws in taiwan is thoroughly reviewed an options based policy evaluation framework is also constructed based on governmental administrative considerations moreover the characteristics of options that lead to unforeseen circumstances during the planning of re development policies are discussed allowing us to derive real time response measures with a decision making value results of this study provide a valuable reference for governmental efforts to evaluate the merits and limitations of related policies concisely ultimately facilitating the formulation of re development policies

an entry and exit model on the energy saving investment strategy with real options this paper presents an improved decision model based on the real options approach presented by ansar and sparks 2009 for the firms that have not yet established energy saving equipment under the entry and exit strategies furthermore the proposed model takes account of the inevitable equipment renewal and the occurrence of unexpected events under the poisson jump process the timing for terminating an investment when continuous operations of that business are unprofitable is also explored to realize the optimal timing of implementing the energy saving strategy the future discounted benefit b follows the geometric brownian motion with the poisson jump process and the replacement of investment equipment a numerical analysis is followed by a sensitivity study of various parameters to better realize their impacts on the entry and exit thresholds the results show that for the jump case the higher probability of occurrence of unfavorable events will result in a higher entry threshold and lower exit threshold investors are forced to request higher benefit thresholds to cover the higher probability of losses brought by unfavorable events

intertemporal capital budgeting abstract this paper analyzes the optimal capital budgeting mechanism when divisional managers are privately informed about the arrival of future investment projects consistent with field study evidence an optimal allocation mechanism can include a stipulation that a capital request for discretionary investment will be declined with positive probability in the period after a significant investment was made even though this is ex post suboptimal the model derives a number of empirical predictions regarding capital budgeting and the investment of financially constrained firms

a real option analysis of investments in hydropower the case of norway abstract this paper presents a valuation study of hydropower investment opportunities in the norwegian context according to nve norwegian water resources and energy directorate the regulator there is a potential of 39 twh not yet developed generation in a normal year is approximately 120 twh by using the conceptual real option framework of dixit and pindyck 1994 investment under uncertainty princeton university press princeton nj one can estimate the value of investment opportunities to nok 11 million gwh eur 1 4 million gwh furthermore the optimal trigger price for initiating an investment based on electricity forward prices is calculated to nok 0 32 kwh eur 0 04 kwh the analysis shows consistency between real option theory and aggregate investment behaviour in norwegian hydropower

budget selection when agents compete abstract a principal selects a budget k of how many projects to fund within an organization and then consults n agents each of whom has private information about his own project s value after receiving cheap talk reports from the agents the principal decides which projects to implement subject to the budget and agents report on new i i d projects every period until the budget is exhausted when the budget is small relative to the number of agents each of whom are biased towards their own projects competition between agents degrades the quality of information conveyed in equilibrium and lowers the principal s payoff a larger budget induces less competition and therefore may be selected in order to extract more information from the agents even though this leads to some unprofitable projects being adopted in an extension i find that a policy of never allowing a funded agent to seek funding again increases payoffs compared to when the agent can always re seek funding

the hidden costs of renewables promotion the case of crop based biogas abstract this paper finds that specific characteristics of bioenergy investments namely long times to build relatively high variable costs and the managerial ability of corrective actions during the project help bioenergy producers to respond to market uncertainties this effect is shown to compromise the economic effectiveness of bioenergy policies the paper compares the effectiveness of financial and regulatory incentive programs aiming to stimulate production of crop based biogas a stylized stochastic real options based investment model is developed to analyze the investment behavior of biogas producers under alternative policies the model is solved by a numerical approach combining stochastic simulations and the genetic algorithm technique unless bioenergy schemes account for structural characteristics of the bioenergy industry they will tend to encourage investments in unused production capacities this would cause additional welfare costs and benefit mainly crop producers

applying real options analysis to assess cleaner energy development strategies abstract the energy industry accounts for the largest portion of co 2 emissions is facing the issue of compliance with the national clean energy policy the methodology for evaluating the energy mix policy is crucial because of the characteristics of lead time embedded with the power generation facilities investment and the uncertainty of future electricity demand in this paper a modified binomial model based on sequential compound options which may account for the lead time and uncertainty as a whole is established and a numerical example on evaluating the optional strategies and the strategic value of the cleaner energy policy is also presented it is found that the optimal decision at some nodes in the binomial tree is path dependent which is different from the standard sequential compound option model with lead time or time lag concept the proposed modified binomial sequential compound real options model can be generalized and extensively applied to solve the general decision problems that deal with the long lead time of many government policies as well as capital intensive investments

hedging the value of waiting abstract we analyze the optimal hedging policy of a firm that has flexibility in the timing of investment conventional wisdom suggests that hedging adds value by alleviating the under investment problem associated with capital market frictions however our model shows that hedging also adds value by allowing investment to be delayed in circumstances where the same frictions would cause it to commence prematurely thus hedging can have the paradoxical effect of reducing investment we also show that greater timing flexibility increases the optimal quantity of hedging but has a non monotonic effect on the additional value created by hedging these results may help explain the empirical findings that investment rates do not differ between hedgers and non hedgers and that hedging propensities do not depend on standard measures of growth opportunities

switching outputs in a bioenergy cogeneration project a real options approach abstract environmental concerns have stimulated the search for economically feasible renewable energy projects one such alternative is the use of biomass for energy generation which has increasingly been the focus of interest traditional valuation methods on the other hand fail to capture the value of the embedded options that exist in many of these projects which may lead to non optimal investment decisions in this article we analyze the feasibility of installing a cogeneration unit in an industrial plant in brazil in order to extract value from biomass residue currently discarded which can be used for thermal and electric energy generation the cogeneration unit also allows the firm the flexibility to optimally choose between an increase in production or the generation of surplus energy for sale in the short term market once additional investment in interconnection to the grid is made we model the uncertainty over future energy prices as a mean reverting process with jumps and seasonality and the embedded flexibility as a bundle of european options under the real options approach the results indicate that the investment in the cogeneration plant is warranted and that the option to switch outputs adds significant value to the project which suggests that biomass residue may be a sustainable energy alternative in this case

the anarchy of numbers the way out of the quagmire he argued was for econometricians to explore larger regions of specification space systematically analyzing the relationship between assumptions and conclusions their evidence the statistical significance in crosscountry panel growth regressions of an interaction term of total aid received and an indicator of the quality of recipient economic policies aid policy section i reviews the approaches and conclusions of the studies that are tested for robustness section ii describes the tests and section iii reports the results the dac considers a loan concessional if it has a grant element of at least 25 percent of the loan value using a 10 percent discount rate in contrast eda includes development loans regardless of how concessional for example it includes loans on nearcommercial terms by the world bank to middle income countries such as brazil but counts only their grant element that is their net present value 264 the world bank economic review diversity

tight bounds on american option prices in contrast to the constant exercise boundary assumed by broadie and detemple 1996 broadie m detemple j 1996 american option valuation new bounds approximations and comparison of existing methods review of financial studies 9 1211 1250 we use an exponential function to approximate the early exercise boundary then we obtain lower bounds for american option prices and the optimal exercise boundary which improve the bounds of broadie and detemple 1996 with the tight lower bound for the optimal exercise boundary we further derive a tight upper bound for the american option price using the early exercise premium integral of kim 1990 kim i j 1990 the analytic valuation of american options review of financial studies 3 547 572 the numerical results show that our lower and upper bounds are very tight and can improve the pricing errors of the lower bound and upper bound of broadie and detemple 1996 by 83 0 and 87 5 respectively the tightness of our upper bounds is comparable to some best accurate efficient methods in the literature for pricing american options moreover the results also indicate that the hedge ratios deltas and gammas of our bounds are close to the accurate values of american options

bounds and prices of currency cross rate options abstract this paper derives the pricing bounds of a currency cross rate option using the option prices of two related dollar rates via a copula theory and presents the analytical properties of the bounds under the gaussian framework our option pricing bounds are useful because 1 they are general in the sense that they do not rely on the distribution assumptions of the state variables or on the selection of the copula function 2 they are portfolios of the dollar rate options and hence are potential hedging instruments for cross rate options and 3 they can be applied to generate bounds on deltas the empirical tests suggest that there are persistent and stable relationships between the market prices and the estimated bounds of the cross rate options and that our option pricing bounds obtained from the market prices of options on two dollar rates and the historical correlation of two dollar rates are highly informative for explaining the prices of the cross rate options moreover the empirical results are consistent with the predictions of the analytical properties under the gaussian framework and are robust in various aspects

average rates of return working capital and npv consistency in project appraisal a sensitivity analysis approach abstract in project appraisal under uncertainty the economic reliability of a measure of financial efficiency such as a rate of return depends on its strong npv consistency meaning that the performance metric i supplies the same recommendation in accept reject decisions as the npv ii ranks competing projects in the same way as the npv iii has the same sensitivity to perturbations in the input data as the npv in real life projects financial efficiency is greatly affected by the management of the working capital using a sensitivity analysis approach and taking into explicit account the role of working capital we show that the average return on investment roi is not strongly npv consistent in accept reject decisions if the working capital is uncertain and changes under changes in revenues and costs also it is not strongly npv consistent in project ranking we also show that the internal rate of return irr is not strongly npv consistent and economic analysis may even turn out to be impossible owing to possible nonexistence and multiplicity caused by perturbations in the input data as well as to possible shifts in the financial meaning of irr under changes in the project s value drivers we introduce the straight line rate of return slrr based on the notion of average rate of change which overcomes all the problems encountered by average roi and irr it always exists is unique strongly npv consistent for both accept reject decisions and project ranking and has an unambiguous financial nature

real options analysis for renewable energy investment decisions in developing countries abstract renewable energy projects in developing countries should provide clean energy supply as well as support sustainable economic development to this end risks arising from uncertainties such as rapidly changing technologies and host government conditions should be carefully addressed however traditional methods for economic assessment are not adequate to support decision making regarding investments in renewable energy this paper proposes a real options analysis framework as a tool to assess renewable energy investment in developing countries a case study involving a hydropower project in indonesia was conducted to validate and verify the proposed framework this framework is expected to help host countries and investors assess renewable energy projects with high volatility and risk

asymmetric information incentives and intrafirm resource allocation this paper considers the question how should a firm allocate a resource among divisions when the productivity of the resource in each division is known only to the division manager obviously if the divisions as represented by their managers are indifferent among various allocations of the resource the headquarters can simply request the division managers to reveal their private information on productivity knowing that the managers have no incentive to lie the resource allocation problem can then be solved under complete or at least symmetric information this aspect is a flaw in much of the recent literature on this topic i e there is nothing in the models considered which makes divisions prefer one allocation over another thus although in some cases elaborate allocation schemes are proposed and analyzed they are really unnecessary in the model we develop a division can produce the same output with less managerial effort if it is allocated more resources and effort is costly to the manager we further assume that this effort is unobservable by the headquarters so that it cannot infer divisional productivity from data on divisional output and managerial effort given these assumptions we seek an optimal resource allocation process our results show that certain types of transfer pricing schemes are optimal in particular if there are no potentially binding capacity constraints on production of the resource then an optimal process is for each division to choose a transfer price from a schedule announced by the headquarters division managers receive a fixed compensation minus the cost of the resource allocated to them at the chosen transfer price resources are allocated on the basis of the chosen transfer prices if there is a potentially binding constraint on resource production a somewhat more complicated but similar scheme is required

valuing investment decisions of renewable energy projects considering changing volatility abstract volatility is an important parameter when evaluating investments using the real options method for renewable energy investments the volatility of cash flow continuously changes because as new information and knowledge are gathered there is less foreseen variation this paper proposes an extended recombining trinomial tree model where the changing volatility is used to generate transition probabilities the changing volatility is generated using a consolidation process where multiple random variables including the market price of electricity carbon price and lending rate are integrated into a low dimension stochastic process a two factor learning curve is used to model the changes of investment cost we apply the proposed model to analyze solar photovoltaic pv power generation investment in china the results show volatility with changing feature compared with constant volatility changing volatility may advance investment decisions and change the project value complete grid parity policy in the solar pv industry is infeasible because the opportunity cost brought by the option of delaying cannot be offset the changing volatility may produce a lower and equally effective subsidy level compared with constant volatility a carbon emission trading scheme is helpful in advancing investments in renewable energy which is reflected in improvements in project value advancements in investment decisions and reductions in the required subsidy level

explicit investment rules with time to build and uncertainty abstract we establish explicit socially optimal rules for an irreversible investment decision with time to build and uncertainty assuming a price sensitive demand function with a random intercept we provide comparative statics and economic interpretations for three models of demand arithmetic brownian geometric brownian and the cox ingersoll ross committed capacity that is the installed capacity plus the investment in the pipeline must never drop below the best predictor of future demand minus two biases the discounting bias takes into account the fact that investment is paid upfront for future use the precautionary bias multiplies a type of risk aversion index by the local volatility relying on the analytical forms we discuss in detail the economic effects for example the impact of volatility on the optimal investment is negligible in some cases it vanishes in the cir model for long delays and in the gbm model for high discount rates

american garch employee stock option valuation abstract we implement a flexible simulation based approach for the fair value of employee stock option eso that accounts for the vesting period departure risk and voluntary suboptimal early exercise we introduce garch effects on the underlying asset and we analyze the price bias with respect to the constant volatility case we also perform a sensitivity analysis with respect to changes in several eso characteristics we compare this valuation with fas 123 method revealing a fas overvaluation finally we value a real eso plan providing the confidence intervals for the estimated eso prices

market in efficiency in valuing electric utilities the case of norwegian generating companies after deregulation of the energy market in norway a number of mergers and acquisitions of hydropower generating companies have taken place however valuation of these companies has proved controversial from an ex post perspective there is support for the criticism that generation assets have been sold too cheaply this article presents a simple valuation model providing evidence of how value has evolved on the basis of these results we discuss the valuation from an ex ante perspective and in the light of the market efficiency hypothesis of fama 1970 1991

an fft network for levy option pricing abstract this paper develops a simple network approach to american exotic option valuation under levy processes using the fast fourier transform fft the forward shooting grid fsg technique of the lattice approach is then generalized to expand the fft network to accommodate path dependent variables this network pricing approach is applicable to all levy processes for which the characteristic function is readily available in other words the log value of the underlying asset can follow finite activity or infinite activity levy processes with the powerful computation of fft the proposed network has a negligible additional computational burden compared to the binomial tree approach the early exercise policy and option values in the continuation region are determined in a way very similar to that of the lattice approach numerical examples using american style barrier lookback and asian options demonstrate that the fft network is accurate and efficient

economic and socio economic assessment methods for ocean renewable energy public and private perspectives this paper provides a comprehensive review of the current state of the art of the economics and socio economics of ocean renewable energy ore the many ways in which the viability and impacts of an ore project are assessed and an analysis of the current weaknesses issues or inappropriateness of the metrics and methodologies used in their definition and presentation the outcomes of this paper are anticipated to benefit the ore and wider renewable sector as a whole the review revealed that for the most part the current study of economics and socio economics of ore remain separate and discrete areas of research the economic methods utilised appear to be comprehensive but are limited to project or private investor level the methods identified for socioeconomic assessment fall between traditional and now routine environmental assessment approaches and more novel holistic approaches such as ecosystem services and life cycle assessment the novel section of the paper explored the connectivity between the economics and socio economics of ore in relation to project developments and policy planning a visualisation method was created of concentric rings intersected by related axis of economic socio economic and environment and enabled the examination of the benefits arising from the connectivity between the two spheres the concept of sustainable development process and the integration of environmental assessment for ore was also explored and how it responds to differing stakeholder aspirations and interpretations the analysis revealed that there was a divergence between public and private economic and socioeconomic assessments for ore environmental assessment is primarily a public responsibility but with significant inputs from the private developer involved while economic assessments are conducted primarily by the developer and or investor at their own behest however the two spheres of economic and socio economic for ore are highly connected and synergistic and must be examined in a holistic manner

an improved method for pricing and hedging long dated american options abstract the majority of quasi analytic pricing methods for american options are efficient near maturity but are prone to larger errors when time to maturity increases we introduce a new methodology to increase the accuracy of almost any existing quasi analytic approach in pricing long maturity american options the new methodology called the extension method relies on an approximation of the optimal exercise price near the beginning of the contract combined with existing pricing approaches so that the maturity range for which small errors are attainable is extended our method retains the quasi analytic nature of the methods it improves generic quasi analytic formulae for the price of an american put as well as for its hedging parameter are derived our scenarios based numerical study indicates that our method considerably improves both the pricing and the hedging performance of a number of established approaches for a wide range of maturities the superiority of this approach is illustrated with real financial data by considering s p 100 tm leaps options traded from january 2008 to may 2015

pumped storage project a short to long term investment analysis including climate change abstract new renewable energy needs flexibility which can be provided by storage hydropower climate change affects the potential of this technology in both a negative and a positive way on one hand by altering runoff and on the other hand by creating new investment opportunity this paper provides an economic and financial analysis of a future project in a pumped storage facility that may be initiated in the swiss alps following the glacier retreat the area released may be considered for building a new reservoir a complete and integrated model is developed based on the tools of analysis provided by econometrics finance and operational research the results show that under the present market conditions such an investment is not profitable unexpectedly the sensitivity analysis shows that most of the time higher price volatility reduces annual revenue furthermore the project s lifetime only has a marginal impact on the net present value the value of the concession which is the right to use water is also assessed on the basis of a real option analysis including a long term horizon its present value is substantial even if the project is currently unprofitable in the discussion we go beyond the swiss case study and highlight the implications for energy policy and market design

real option valuation in renewable energy literature research focus trends and design abstract in light of intensive development of the renewable energy re sector a growing number of academic papers address the complexity of re investment planning and valuation to take account of the high risk profile and irreversibility of re investments researchers have resorted to sophisticated real options ro approaches that enable flexibility to be incorporated into project design in the face of an uncertain environment the variety of different frameworks and models adopted as well as a lack of aggregated analysis of the field suggest a need for a critical review of ro methodology and design in re assessment this study describes the research focus trends and design found in contemporary academic literature devoted to re valuation with a ro approach particular attention is given to ro in project and policy design the results give a comprehensive picture of existing research on the topic thus providing researchers with a solid foundation for further study and indications of directions for future development furthermore the findings provide policymakers and project planners with valuable insights into key aspects of re project and policy design

robust pricing of the american put option a note on richardson extrapolation and the early exercise premium this paper presents a detailed analysis of the numerical implementation of the american put option decomposition into an equivalent european option plus an early exercise premium kim 1990 jacka 1991 carr et al 1992 it subsequently introduces a new algorithm based upon this decomposition and richardson extrapolation this new algorithm is based upon a the derivation of the correct order for the error term when applying richardson extrapolation which is used to control the error of the extrapolated prices b an innovative adjustment of kim s 1990 discrete time early exercise premium so that these premiums monotonically converge and therefore it is appropriate to use them in extrapolation and c the optimal exercise frontier can be quickly computed through newton s method permitting the efficient implementation of the decomposition formula in practice numerical experiments show that this new algorithm is accurate efficient easy to implement and competitive in comparison with other methods finally it can also be applied to other american exotic securities

investing in finite life carbon emissions reduction program under risk and idiosyncratic uncertainty this paper aims at emphasizing the ability of new frameworks of real option model to highlight key characteristics of industrial carbon emissions reduction program investment decision we develop both theoretical arguments and numerical simulations with structural parameters calibrated on real life data we find that both radical uncertainty and risk lead to speed up green investments compared to the predictions of real option models that are normally used in green investment literature the conventional wait and see attitude questioned in recent developments of the real option theory is not validated in conclusion our results should foster companies to implement green investments and help governments to define appropriate incentives to encourage green investments of particular note the paper highlights that finance theory is not necessarily an obstacle to green investment decisions

a theory of socialistic internal capital markets abstract we develop a model of a two division firm in which the strong division has on average higher quality investment opportunities than the weak division we show that in the presence of agency and information problems optimal effort incentives are less powerful and thus managerial effort is lower in the strong division this leads the firm to bias its project selection policy against the strong division the selection bias is more severe when there is a larger spread in the average quality of investment opportunities between the two divisions

the capital budgeting process incentives and information we study the capital allocation process within firms observed budgeting processes are explained as a response to decentralized information and incentive problems it is shown that these imperfections can result in underinvestment when capital productivity is high and overinvestment when it is low we also investigate how the budgeting process may be expected to vary with firm or division characteristics such as investment opportunities and the technology for information transfer there is general agreement that investment decisions are the most important decisions made by corporations the choice of projects and the level of investment is critical not just for stakeholders of the firm but also for the economic well being of society as a whole it has been alleged that u s firms invest too little and tend to overemphasize short term results for example porter 1992 citing poterba and summers 1992 asserts that u s firms use hurdle rates to evaluate investment projects that are higher than their estimated costs of capital to understand the investment behavior of firms one must consider both the process by which external capital is made available to firms and the process by which internally and externally raised capital is allocated to investment projects within the firm considerable attention has been paid to how firms raise external capital the fundamental insight in this area is the celebrated result of modigliani and miller mm that capital structure is irrelevant in the absence of capital market frictions accordingly in the three decades since their contribution research on how external capital is raised has focused on market frictions including information and incentive problems relatively little research has focused on the internal allocation process and its relationship to the organization of the firm modern finance theory prescribes allocating capital according to the net present value npv rule just as the mm result itself provides no theory of the arrangements under which

valuing chinese feed in tariffs program for solar power generation a real options analysis newhuadu business school research fund china sustainable energy program g 1305 18257 national social science foundation of china 12zd059 ministry of education 10gbj013

time to build option value and investment decisions abstract investment decisions and outlays are often made sequentially for example the rate at which construction proceeds is usually flexible and can be adjusted with the arrival of new information traditional discounted cash flow methods which treat the pattern of investment as fixed ignore this flexibility and understate the value of the project this paper uses contingent claims analysis to derive optimal decision rules and to value such investments we determine the effects of time to build opportunity cost and uncertainty on the investment decision for reasonable parameter values we show how a simple npv rule can lead to gross errors

the use of real options approach in energy sector investments abstract energy shortage global warming and climate change led to an increase in the use of alternative sources of energy with renewable energy sources res playing a fundamental role in this new energetic paradigm however the investment costs often constitute a major barrier to their spread use moreover the overall benefits of renewable energy technologies are often not well understood and consequently they are often evaluated to be not as cost effective as traditional technologies from the moment that the energy sector started a deregulation process with a high level of competitiveness and associated increased market uncertainty traditional project evaluation techniques alone became insufficient to properly deal with these additional risk and uncertainty factors the diffusion of the renewable energy technologies is also affected by this feature the way investors evaluate their investments call now for the use of more sophisticated evaluation techniques real options approach can deal with these issues and as so began to be considered and applied for the energy sector decision aid this approach it is now extensively widespread in evaluating investment projects in the energy sector a large set of applications in almost all fields of energy decision making from electricity generation technologies appraisal to policy evaluation is available in the literature however the use of this technique in the field of res is still limited and worth to be analysed this paper addresses this issue a review of the current state of the art in the application of real options approach to investments in non renewable energy sources and res is presented giving perspectives for further research in this field

aid and growth regressions this paper examines the relationship between foreign aid and growth in real gdp per capita as it emerges from simple augmentations of popular cross country growth specifications it is shown that aid in all likelihood increases the growth rate and this result is not conditional on good policy there are however decreasing returns to aid and the estimated effectiveness of aid is highly sensitive to the choice of estimator and the set of control variables when investment and human capital are controlled for no positive effect of aid is found yet aid continues to impact on growth via investment we conclude by stressing the need for more theoretical work before this kind of cross country regressions are used for policy purposes

generalized analytical upper bounds for american option prices this paper generalizes and tightens chen and yeh s 2002 analytical upper bounds for american options under stochastic interest rates stochastic volatility and jumps where american option prices are difficult to compute with accuracy we first generalize theorem 1 of chen and yeh 2002 and apply it to derive a tighter upper bound for american calls when the interest rate is greater than the dividend yield our upper bounds are not only tight but also converge to accurate american call option prices when the dividend yield or strike price is small or when volatility is large we then propose a general theorem that can be applied to derive upper bounds for american options whose payoffs depend on several risky assets as a demonstration we utilize our general theorem to derive upper bounds for american exchange options and american maximum options on two risky assets

wind power reliability valuation in a hydro dominated power market the colombian case abstract the design of market mechanisms that remunerates the reliability provided by a generator in a power market is a task that aims to ensure the normal operation of the system for the case of a hydro dominated system when wind power is introduced and operated under the merit order effect it is possible to assess the effect of the displacement of hydro generation due to wind generation over the system s reliability in terms of firm energy taking this into account a model that valuates the firm energy provided by wind power in a hydro dominated system is proposed this model considers the effect of wind power over the system s reservoirs and the market price of electricity and valuates the firm energy as the net savings of the system related to the increase in the firm energy of the system when wind power is introduced the results show that wind power under merit order effect increases the firm energy of the system and decreases the market price of electricity being the net savings in comparison to the corresponding hydro only system the reliability income that should be perceived by the wind power generator

aid and performance a reassessment two visions of aid effectiveness and allocation are compared the first corresponding to the new aid paradigm argues that aid is only effective if domestic policies are appropriate the second in contrast argues that aid effectiveness depends on the external and climatic environment the worse this environment or the more vulnerable the recipient countries the greater the effectiveness of aid cross sectional econometric tests related to gdp growth on two 12 year pooled periods clearly favour the second view the two views can be reconciled through the principle of performance based aid allocation where performance is defined as outcomes adjusted for the impact of environmental factors performance can then be measured in several manners which are subject to comparison one approach would lead one to allocate more aid the worse the external environment is for a given policy and the better the policy is for a given environment

capital rationing and organizational slack in capital budgeting this paper reconciles three stylized facts about capital budgeting in firms and shows that they are tied to the presence of asymmetric information among the several members of the firm each with his or her own objectives and decisions the facts of interest are 1 the existence of organizational slack 2 the rationing of resources within organizations 3 the stated cut off rate for accepting capital projects in firms is often greater than the market rate of interest organizational slack is defined as the excess of resources allocated over the minimum necessary to accomplish the tasks assigned resource rationing is defined as the under allocation of resources i e an increase in the amount allocated would generate revenues in excess of its costs rationing and slack are both manifestations of ex post inefficiencies an lp model is used to show that these inefficiencies can occur in ex ante efficient organizational designs when asymmetric information is present the optimal allocation policy involves a hurdle rate criterion in which the hurdle rate is strictly in excess of the cost of capital thus inducing rationing in some states of the world typically resources are optimally allocated such that slack exists in other states the optimal allocation policy trades off these two inefficiencies