| During the last ten years, increasing attention has been given to the real option approach to capital investment decision-making. Real options are a type of option where the underlying asset is a real asset, not a financial asset. They exist when managers have the opportunity, but not the requirement, to alter the firm's investment strategy. To date, the primary frameworks used to model and value investment opportunities having real options are (1) decision tree models and (2) option-based models, which use either the binomial or continuous-time option pricing techniques. This dissertation introduces influence diagrams as an alternative decision-making framework for modeling and valuing investment opportunities having real options.; Specifically, this dissertation discusses the underlying assumptions, the strengths, and the weaknesses of decision tree models and option-based models and then reviews a variety of papers from the real options literature where real options are actually modeled and valued. Next, influence diagrams are introduced and discussed and, finally, examples of traditional real option problems are each modeled and valued using a decision tree, an option-based, and an influence diagram model.; This dissertation argues (1) influence diagram models represent decision problems in a more descriptive, intuitive, and compact manner than decision tree or option-based models, (2) influence diagram models and decision tree models are mathematically equivalent, and (3) for modeling and valuing investment opportunities having real options and under certain conditions, influence diagram models and option-based models give the same valuations and optimal strategies. Finally, given the influence diagram decision-making framework can readily be used by corporate managers to model and value real options investment opportunities, this research may provide a means for effectively bringing real options valuation into the applied arena. |
