Sunday 2013-01-13

Real Options by Tom Copeland and Vladimir Antikarov

One of my recently-minted-MBA friends mentioned that "real options" were all the rage in MBA decision science nowadays. Back in 2003, we were taught decision tree analysis (DTA) and net present value (NPV), so let's see what exactly is now being pushed.

Real options augment DTA with 1970s-style basic Black-Scholes (BS) options valuation. Keep in mind that anyone in financial markets today using a basic BS will have their faces ripped off, as 1) many returns are not normally distributed, and 2) probability estimation needs to be adjusted by the capital allocator's past ability to estimate, and 3) I'm nowhere near the cutting edge of decision / risk / valuation practices.

As the authors' indicate, real options has been helped by the advent of spreadsheet binomial trees and linear algebra "solvers". I.e. the frontier of mass decision science is predicated upon the ease of user computability.

The book has a chapter written by John Stonier, the Marketing Director of Airbus, which depicts Airbus' decision science team split as to a certain problem's analysis. They should have talked with their finance team. If they're the same team, Airbus is in a world of hurt.