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Using Binomial Decision Trees to Solve Real-Option Valuation Problems

Using Binomial Decision Trees to Solve Real-Option Valuation Problems,10.1287/deca.1050.0040,Decision Analysis,Luiz E. Brandão,James S. Dyer,Warren J.

Using Binomial Decision Trees to Solve Real-Option Valuation Problems   (Citations: 26)
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T raditional decision analysis methods can provide an intuitive approach to valuing projects with managerial flexibility or real options. The discrete-time approach to real-option valuation has typically been imple- mented in the finance literature using a binomial lattice framework. Instead, we use a binomial decision tree with risk-neutral probabilities to approximate the uncertainty associated with the changes in the value of a project over time. Both methods are based on the same principles, but we use dynamic programming to solve the binomial decision tree, thereby providing a computationally intensive but simpler and more intuitive solu- tion. This approach also provides greater flexibility in the modeling of problems, including the ability to include multiple underlying uncertainties and concurrent options with complex payoff characteristics.
Journal: Decision Analysis - DECIS ANAL , vol. 2, no. 2, pp. 69-88, 2005
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