Technical Note on the Valuation of Real Options

This note offers an overview of different types of real options and the techniques that are available to value them. Practical application issues and guidelines are offered for those beginning to implement real options analysis.

The note enables students to understand the taxonomy of real options, the limitations associated with techniques such as discounted cash flow analysis and decision tree analysis, and valuation basics (e.g., Black-Scholes, replicating portfolios, risk-neutral valuation, and approximation methods). The note concludes with a set of guidelines for common application issues.