Real Options Theory in Financial Modeling Analytical Essay by edjata

Real Options Theory in Financial Modeling
Looks at the use of the real options theory in financial modeling and management especially in the field of petroleum property valuation.
# 152512 | 2,315 words | 17 sources | APA | 2013 | US
Published on Mar 04, 2013 in Business (Industries) , Economics (Econometrics) , Business (Management)

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This paper explains that the real option theory is a system by which decisions are pliable to alternative choices due to unanticipated market changes enabling managers to adapt quickly to these environment and market changes. Next, the author demonstrates the application of the real option theory to analyze and valuate the cultivation of oil and gas commodities in the petroleum industry. Of the many variations of this theory, the paper recommends the binomial model because it allows managers to evaluate the cost effectiveness of investing in one project over another, which long-term maximizes profits on invested funds.

Table of Contents:
What is Real Option Theory?
Risk Opportunity
Petroleum Property Valuation
Petroleum Utilization of Real Options
Over-committing To Real Options
Real Option Valuation Models

From the Paper:

"There are individuals that believe the problem with real options being part of the decision framework is that those over committed to a project may not know when to exit a failing project. In some situations if a manager, partner or investor has invested too much money into a project that they believed would be successful, they may feel a sense of obligation to see the project out. Even when they realize the projections are wrong or the outcome will be unsuccessful, they continue to see it out and stay fully committed. Some people find that real options just cause a higher level of escalation when it comes to a projects responsibility. In this article "Do real options lead to escalation of commitment?" Zardkoohi analyzed the increased commitment to clearly unsuccessful or failing projects and the resistants to ending the project. According to the findings this is located external to unregulated for profit organizations. Stakeholders stay optimistic throughout. Moreover, researchers have found that those with a higher level of responsibility for a project are less likely to let go of the project, even as it is sinking.
"The initial stage of financing for fuel companies is acquiring the rights for mineral lands called toehold investments in order to drill, extract and store."

Sample of Sources Used:

  • Ross, S., Westerfield, R. W., Jaffe, J. F., & Jordan, B. D. (2011). Corporate finance: Core principles and applications (3rd ed.).
  • artolomeu Fernandes, J. C. (2011). The use of real options approach in energy sector investments. Retrieved July 1, 2012, from Renewable and Sustainable Energy Reviews:
  • Hengels, A. (2003). Creating a Practical Model Using Real Options to Evaluate Large-Scale Real Estate Development Projects. Retrieved July 1, 2012, from
  • Mbolo, T. U. (2008, May 15). Project Valuation using Real. Retrieved July 1, 2012, from Swiss Federal Institute of Technology Zurich:
  • Mooren, P. (2011, September). The Value of Real Options Valuation: A Case Study. Retrieved July 1, 2012, from

Cite this Analytical Essay:

APA Format

Real Options Theory in Financial Modeling (2013, March 04) Retrieved June 20, 2021, from

MLA Format

"Real Options Theory in Financial Modeling" 04 March 2013. Web. 20 June. 2021. <>