Real Options Valuation Based on Certainty Equivalents

Main Article Content

Cecilia Maya Ochoa
Julián Pareja Vasseur

Keywords

real options, utility function, certainty equivalent, incomplete markets, CRRA

Abstract

This purpose of this research is to identify appropriate rates to discount the flows from real options in situations in which the risk-free rate does not apply, in particular, in incomplete markets.  A methodology is proposed for valuing real options based on certainty equivalence, which requires as a principal condition the consideration of preferences represented with utility functions.  A constant relative risk aversion (CRRA) utility function is used to represent these preferences. The results indicate that this methodology adequately reflects how the value of a real option changes in accordance with an investor´s preferences.

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