Impact of Probability Distributions on Real Options Valuation
Publication: Journal of Infrastructure Systems
Volume 22, Issue 3
Abstract
This paper shows that the choice of the type of probability distribution is crucial in Real Options Analysis, because it could lead to different outcomes. This is illustrated by using the beta distribution and its special cases, such as the Program Evaluation and Review Technique (PERT) and uniform distribution to model parking garage demand uncertainty. These distributions are commonly used when there are no data available about the stochastic variable, i.e., demand uncertainty. Beta distributions are more flexible than the PERT and uniform distribution. One of the major challenges is the practicality of the beta distribution. A good solution to this challenge is provided by the PERT distribution, because of its ease-of-use and greater flexibility than the uniform distribution. In this research, a parking garage case example is used as the base case for modeling of the parking garage demand and is refined to allow for more generic, flexible, and practical applications of the model. The impact of different probability distributions is studied on the basis of an expansion option.
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Acknowledgments
The author appreciates the cooperation of Dr. A.G Chessa who worked with the author on the implementation of the beta distribution. The author is very grateful for the reviews of Dr. D. Cassimon, Dr. Mr. P.J. Engelen, and Prof. Dr. Ir. A. K. Hajdasinski. The comments of two anonymous referees were instrumental in improving the quality of this paper.
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Published In
Journal of Infrastructure Systems
Volume 22 • Issue 3 • September 2016
Copyright
© 2016 American Society of Civil Engineers.
History
Received: Dec 24, 2014
Accepted: Oct 28, 2015
Published online: Feb 1, 2016
Discussion open until: Jul 1, 2016
Published in print: Sep 1, 2016
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