Applying Monte Carlo Simulation To Obtain A Real Options Result

Monte Carlo simulation can be applied to solve a real options problem, that is, to obtain an option result. Recall that the mainstream approaches in solving real options problems are the binomial approach, closed-form equations, partial-differential equations, and simulation. In the simulation approach, a series of forecast asset values are created using the Geometric Brownian Motion, and the maximization calculation is applied to the end point of the series, and discounted back to time zero,...

Case Study Option To Abandon

Suppose a pharmaceutical company is developing a particular drug. However, due to the uncertain nature of the drug's development progress, market demand, success in human and animal testing, and FDA approval, management has decided that it will create a strategic abandonment option. That is, at any time period within the next five years of development, management can review the progress of the research and development effort and decide whether to terminate the drug development program. After...

The Capm Versus The Multifactor Assetpricing Model

The CAPM model states that under some simplifying assumptions, the rate of return on any asset may be expected to be equal to the rate of return on a riskless asset plus a premium that is proportional to the asset's risk relative to the market. The CAPM is developed in a theoretical and hypothetical world with multiple assumptions6 that do not hold true in reality, and therefore it is flawed by design.7 The alternative is to use a multifactor model that adequately captures the systematic risks...