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Pricing the Planet's FutureThe Economics of Discounting in an Uncertain World$
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Christian Gollier

Print publication date: 2012

Print ISBN-13: 9780691148762

Published to Princeton Scholarship Online: October 2017

DOI: 10.23943/princeton/9780691148762.001.0001

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The Option Value of Uncertain Projects

The Option Value of Uncertain Projects

Chapter:
(p.203) 13 The Option Value of Uncertain Projects
Source:
Pricing the Planet's Future
Author(s):

Christian Gollier

Publisher:
Princeton University Press
DOI:10.23943/princeton/9780691148762.003.0013

This chapter first illustrates the notion of an option value with a simple numerical example, before examining a more sophisticated application with a Poisson two-armed bandit. In the first case, there is an option value to wait. In the second case, there is an option value to experiment. The theory of real option value has the objective to adjust the standard cost-benefit methodology, which is static by nature, in order to integrate these dynamic aspects of the evaluation problem. The computation of option values must be done by backward induction. At each node of the decision tree, the optimal decision is made by taking into account the optimal decisions in the subsequent nodes of that part of the tree.

Keywords:   option value, uncertain projects, Poisson two-armed bandit, backward induction, risk management, net present values, NPV

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