Several Options For Pricing And Simulating Using Monte Carlo Method

The traditional methods of investment decision analysis, especially NPV and IRR, are based on the following assumptions: the investment is reversible, or, if it is irreversible, it is a now or never proposition. But in reality, most of investments do not meet these conditions. Many of them are either irreversible, or partial reversible, and they also have the possibility of delay, hence management flexibilities do exist. These flexibilities have values which are similar to financial call options, therefore we can evaluate them by, say, real option approach. Empirical researches show that these values can be greatly large, hence ignoring them will cause very wrong investment decision. There are many literatures on real options now and it will no doubt be a prominent method in evaluating investment project.In this paper, I first price some options by using transition probability matrix when interest rates are followed Markov progress, including the discrete time case and the continuous time case. Then I evaluate a class of R&D projects with option to contract its scale under constant tax rate by Greenian Approach and obtain the project values and most optimal thresholds. By comparison static method I analyze how some related factors affect them. After that, I evaluate a class of R&D projects under product life cycle. Finally, because the traditional numerical method, such as finite difference method and binomial tree method can not solve option pricing problem when the dimension are larger than three, I use Monte Carlo simulation to evaluate some financial options and real options.