Real Options and Investment under Uncertainty

This course considers the application of option concepts from finance to value real assets. The focus is on using real options theory and methodology to value investments characterized by uncertainty, irreversibility, and flexibility in the timing of irreversible expenditures. The course begins with an introduction to stochastic processes, Ito's Lemma, the Black-Scholes equation, contingent claims analysis and dynamic programming. Methods to solve simple option value problems will be presented, such as binomial trees and Monte Carlo simulation. Applications will focus on problems in natural resource and environmental economics, such as valuing the option to drill for oil or install pollution control equipment and, time permitting, other applications in economics.