Real Options for Real Ventures

Berkley Center for Entrepreneurial Studies Working Paper No. BCES-02-05

13 Pages Posted: 26 Apr 2004

See all articles by Hollister B. Sykes

Hollister B. Sykes

New York University (NYU) - Berkley Center for Entrepreneurial Studies

Date Written: January 31, 2004

Abstract

Black-Scholes is useful for valuing real options, but not in the way often used for new ventures. The use rests on an apparent analogy between real and stock options. Although conceptually helpful, a direct analogy is flawed for most real ventures. The most critical flaw is the assumption that the variance in new venture outcomes is a continuous time function and must be derived from a so-called tracking stock. The analogy also requires that the present value of venture cash flows be the equivalent of a current stock price in the Black-Scholes equation. Determining this certainty equivalent requires subjective inputs, for which guidance is usually lacking. This paper reviews the analogy problems and ways to resolve them for new venture situations, including the problem of estimating risk discounts for new ventures.

Keywords: Black Scholes, real options, risk discounts, Monte Carlo simulation

JEL Classification: C15, C44, G12, G13, G31, M21

Suggested Citation

Sykes, Hollister B., Real Options for Real Ventures (January 31, 2004). Berkley Center for Entrepreneurial Studies Working Paper No. BCES-02-05, Available at SSRN: https://ssrn.com/abstract=515949 or http://dx.doi.org/10.2139/ssrn.515949

Hollister B. Sykes (Contact Author)

New York University (NYU) - Berkley Center for Entrepreneurial Studies ( email )

Henry Kaufman Management Center
44 West 4th Street
New York, NY 10012
United States

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