Advanced approaches of real options applied in decision making

Huanyu Li

Doctoral thesis

Abstract:

There has been a growing number of academics and corporate practitioners feeling unsatisfactory with the current approach to decision-making, suggesting that there is some gap between existing financial theory and corporate practice. Many times, policymakers are willing to abandon conventional investment criteria in order to allow for operational flexibility and other strategic factors. However, in a real market characterized by rapid changes, uncertainty and competition, decision makers can often be flexible, staged or even adopt different strategies based on different information. The flexibility of this decision-making is similar to that of financial options, so real options are introduced into the strategic decision-making of enterprises. The objective of the doctoral thesis is to apply and verify the decision making for the enterprises to choose the correct investment based on the advanced real options methodology under stochastic and fuzzy uncertainty with interaction (game theory) in continuous time. The continuous time series model, Geske (1979) model is applied as the basic advanced model in this doctoral thesis. This model is a two-phase model using evaluate the compound real option, and the early investment opportunity is precondition for the following investment. Some basic research based on real option had done before, and prove real option can better valuated project compared with tradition NPV net present value), IRR (internal rate of return), PI (profit index) and so on. The fuzzy number applied in Geske model offer more possibility for investors to see the final result is not a specific number, but at a range with different cuts. It gives a positive result as upper limit and negative result as lower limit. For the further study, uncertainty always exist in the market, like internal and external uncertainty. The third model fully consider the external market uncertainty and introduce the game environment for different conditions. On this basis, the thesis from two sides of enterprise competitive position in the market and competitor’s reactions, analysis the selection decision making with first mover advantage and follower advantage. Through derived differential equations for the technical, commercial and sudden uncertainties, it builds corresponding investment decision making payoff models. Thus, advanced approaches of real options are built and offer the different valuation methods for decision maker. The doctoral thesis results based on the electricity car industry companies’ data, valuations and strategies are got are expected to provide the explicit two investment stage in their whole investment plan.

Abstract:

There has been a growing number of academics and corporate practitioners feeling unsatisfactory with the current approach to decision-making, suggesting that there is some gap between existing financial theory and corporate practice. Many times, policymakers are willing to abandon conventional investment criteria in order to allow for operational flexibility and other strategic factors. However, in a real market characterized by rapid changes, uncertainty and competition, decision makers can often be flexible, staged or even adopt different strategies based on different information. The flexibility of this decision-making is similar to that of financial options, so real options are introduced into the strategic decision-making of enterprises. The objective of the doctoral thesis is to apply and verify the decision making for the enterprises to choose the correct investment based on the advanced real options methodology under stochastic and fuzzy uncertainty with interaction (game theory) in continuous time. The continuous time series model, Geske (1979) model is applied as the basic advanced model in this doctoral thesis. This model is a two-phase model using evaluate the compound real option, and the early investment opportunity is precondition for the following investment. Some basic research based on real option had done before, and prove real option can better valuated project compared with tradition NPV net present value), IRR (internal rate of return), PI (profit index) and so on. The fuzzy number applied in Geske model offer more possibility for investors to see the final result is not a specific number, but at a range with different cuts. It gives a positive result as upper limit and negative result as lower limit. For the further study, uncertainty always exist in the market, like internal and external uncertainty. The third model fully consider the external market uncertainty and introduce the game environment for different conditions. On this basis, the thesis from two sides of enterprise competitive position in the market and competitor’s reactions, analysis the selection decision making with first mover advantage and follower advantage. Through derived differential equations for the technical, commercial and sudden uncertainties, it builds corresponding investment decision making payoff models. Thus, advanced approaches of real options are built and offer the different valuation methods for decision maker. The doctoral thesis results based on the electricity car industry companies’ data, valuations and strategies are got are expected to provide the explicit two investment stage in their whole investment plan.

Keywords

Real option, Geske Model, Fuzzy number, Game theory, Decision Making

Keywords

Real option, Geske Model, Fuzzy number, Game theory, Decision Making

Language used: English

Date on which the thesis was submitted / produced: 12. 5. 2024

Thesis defence

• Supervisor: Zdeněk Zmeškal

VSB – Technical University of Ostrava

Ekonomická fakulta

Doctoral programme / field:
Hospodářská politika a správa / Finance