From: jim.dyer@bus.utexas.edu
To: vince.j.kaminski@enron.com
Date: 2000-03-31 15:11:00+00:00
Subject: Presentation at UT

Vince,

 I appreciate your response to my request for you to speak to my
class on real options.  I thought you might enjoy the following exchange of
emails that occurred yesterday.  Perhaps some of these issues could be
addressed in your talk.

 Jim



-----Original Message-----
From: Sheridan Titman
Sent: Friday, March 31, 2000 9:11 AM
To: Jim Dyer
Subject: RE: Real Options Course Feedback


Jim:

Your student has raised some difficult questions.  I would recommend Ehud,
but I thought that the finance people have the answers in cases with
complete markets and that we rely on the decision science people for cases
with incomplete markets.

If it would help, I can come in at 6pm after my class in a couple of weeks.

Sheridan

Sheridan Titman
Department of Finance
College of Business Administration
University of Texas
Austin, Texas 78712-1179

512-232-2787 (phone)
512-471-5073 (fax)

titman@mail.utexas.edu


-----Original Message-----
From: Jim Dyer
Sent: Thursday, March 30, 2000 4:37 PM
To: Sheridan Titman
Subject: RE: Real Options Course Feedback


Sheridan,

 Which of your classes do you want to miss?  Just kidding.  Actually
you probably told me that before.  Can you suggest someone else who would be
a good choice to discuss the use of option theory in the context of
incomplete markets, and to address some of the types of questions raised in
the note from the student?

 Jim

-----Original Message-----
From: Sheridan Titman
Sent: Thursday, March 30, 2000 5:58 PM
To: Jim Dyer
Subject: RE: Real Options Course Feedback


Jim:

I teach at the same time as you do.

Sheridan

Sheridan Titman
Department of Finance
College of Business Administration
University of Texas
Austin, Texas 78712-1179

512-232-2787 (phone)
512-471-5073 (fax)

titman@mail.utexas.edu


-----Original Message-----
From: Jim Dyer
Sent: Thursday, March 30, 2000 11:32 AM
To: Sheridan Titman
Subject: FW: Real Options Course Feedback


Sheridan,

 See the comments below.  I don't mean to put you on the spot, and
have not announced anything in class, but I am hoping that you could visit
my class for about an hour one Thursday afternoon to discuss your views
regarding applications of option pricing concepts to "real options".  As a
reminder, I've attached a course outline.  Chris Kenyon from Schlumberger is
speaking on April 13, and Vince Kaminski has tentatively agreed to speak on
April 20.

 I am going to be out of town on April 27, so that leaves either next
Thursday (April 6) or May 4.  Would either of those times work for you?  I'm
not thinking of any preparation, but more of an informal discussion of the
"philosophical issues" related to real options work.

 Jim



-----Original Message-----
From: Jim Dyer
Sent: Thursday, March 30, 2000 1:24 PM
To: 'jclevenger@optionii.bus.utexas.edu'
Subject: RE: Real Options Course Feedback


Josh,

 Some very thoughtful observations.  As you know, I had invited one
finance professor to our class on Arundel, but he was out of town.  I do
plan to invite Sheridan Titman to discuss the issue of using the option
models in situations where there is no underlying security that is traded.
I do think it is important to face that issue, which is actually covered at
a theoretical level in our last couple of readings.

 The issue of volatility is also an excellent issue for further
discussion, as you suggest.  So far, we've been looking at cases where
volatility is "given".  The problem of finding an "objective" measure of
volatility for a project reminds me of the problem of finding the correct
risk adjusted discount rate, which is not surprising since the concepts are
almost two sides of the same plate.  One approach, of course, is to do some
modeling using traditional decision analysis tools, including subjective
probabilities, but the finance people who write options articles don't like
to think  about such ideas.

 I'll try to address these issues in more detail as the semester
continues.  I think it was important to surface some of these points early,
and to come back to them after we have seen how to apply the methods in a
naive sort of way.

 Thanks for the feedback and comments.

 Jim

-----Original Message-----
From: jclevenger@optionii.bus.utexas.edu
[mailto:jclevenger@optionii.bus.utexas.edu]
Sent: Thursday, March 30, 2000 8:42 AM
To: Jim.Dyer@bus.utexas.edu
Cc: josh-clevenger@reliantenergy.com
Subject: Real Options Course Feedback




After overcoming the initial (I hope) overload of materials and tools
presented
thus far in the semester, it appears to me that you are achieving the
objective
of making us comfortable with optionality valuation as applied to a variety
of
problems which are outside the borders defined by a liquid market of traded
financial elements.

As a constructive feedback, you have been forthright with us in marking off
areas of this subject which are still controversial.  I also realize that
rightly so, real-world application of this type of analysis without a robust
understanding of finance may degenerate into a succession of assumptions
that
result in a "house of cards" effect.  My opinion at this point is that two
issues are of potentially "make-or-brake" importance if I am to persuade my
superiors to accept these methods for valuations outside the realm of
projects
whose value is primarily driven by the value of commodities backed by
financial
instruments.  These issues are easy to guess:

1)  Discounting and Risk Free rates:  I do not sense that anyone in the
class
has put forth convincing arguments as to the proper application of time
value
questions in the absence of liquidity.  Is there someone within the finance
department that can present a firmer position on this question?

2)  Volatility: I found Winston's examples on this metric succinct.  I would
recommend that in future years you dedicate some hours of class time to this
subject.  My criticism again relates to messy problems.  I anticipate
arguments
against real option applications based on the dispute of volatility
measures.
If I were a conservative financial manager, I would argue that:

*** Two-a: implied volatility derived from an industry specific slice of
equity
options is a shotgun approach -- the projects being valued are of a tranche
which may in fact have a significantly different outcome variance than the
weighted average measured by the equities utilized.  Oil, gas and electricty
are
good examples the major players are competing on many different levels of
the
value chain. Smaller companies do exist which are dedicated to one strata,
but
what about projects that want to exploit opportunies across strata in a
vertically integrated company?

*** Two-b: based on the following skepticism - if a real option value is
being
proposed for a new business venture (some new unexploited opportunity,)
there is
some paradox embedded in the increased value based on high volatility in new
ventures and the high risk of failure.  This skepticism is likely to be less
acute in high-tech sectors where the huge upside of new ventures is paraded
before us daily by NASDQ touts.  It is a much harder sell to "mature"
industries.

Of particular interest in the power industry are investments centered around
opportunities arising from restructuring of electricity and natural gas
sectors
as regulation is removed.  A large proportion of the risk is embedded in
ongoing
changes of public policy on an international basis.  As an intentionally
screwed-up example, can anyone other than a financial genius correctly asses
volatility for U.S. companies investing in seed projects in Mexico based on
speculation of the inevitable dismantling of the national utility (CFE) and
PEMEX?



James S. Dyer
Fondren Centennial Chair in Business
Department of Management Science and Information Systems
CBA 5.202
The University of Texas at Austin
Austin, Texas 78712-1175

Email:  j.dyer@bus.utexas.edu
Telephone:  512-471-5278
Fax:  512-471-0587