Journal article

Real-Option Valuation in a Finite-Time, Incomplete Market with Jump Diffusion and Investor-Utility Inflation

Timothy Hillman, Nan Zhang, Zhuo Jin

Risks | MDPI AG | Published : 2018

Abstract

We extend an existing numerical model (Grasselli (2011)) for valuing a real option to invest in a capital project in an incomplete market with a finite time horizon. In doing so, we include two separate effects: the possibility that the project value is partly describable according to a jump-diffusion process, and incorporation of a time-dependent investor utility function, taking into account the effect of inflation. We adopt a discrete approximation to the jump process, whose parameters are restricted in order to preserve the drift and the volatility of the project-value process that it modifies. By controlling for these low-order effects, the higher-order effects may be considered in isol..

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University of Melbourne Researchers