When modeling the right to develop an oil property as a real option, and in the...
When modeling the right to develop an oil property as a real option, and in the presence of fixed costs, using oil price volatility in the option-pricing model will __________ the value of the option.
a. underestimate because the value of the option depends on the volatility of cash flow (profit)
b. underestimate because the value of the option depends on the volatility of revenue
c. overestimate because the value of the option depends on the volatility of revenue
d. overestimate because fixed costs make revenue more volatile than profit
Homework Answers
Option C i.e. "overestimate because the value of options depends upon the volatility of revenue" is the correct answer.
The more volatile the market is, the more would be our range for determining the option premium. This would ultimately lead to overestimating the premium value.
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When modeling the right to develop an oil property as a real
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