Real Options Evaluation And Dominance Analysis For The Investment Strategy Of Two Projects Portfolio

Real options approach has been the main method in risky projects assessment and investment decision-making problems. The existed researches mainly focus on quantitative evaluation analysis for a real option or compound real options on single project, while only few literatures discussed quantitative decision analysis for portfolio on multiple projects. In this paper, real option evaluation and strategies selection on the combination of two projects are discussed. The portfolio's price process is given by Douglas production function by which we analyze the risk and return of the portfolio. Based on risk-return relationship and the option value of investment opportunities, we consider investment decision-making under different combinations. The paper has solved the following issues: the combination set of specific models, the interaction effect between investment options and the evaluation analysis of portfolio.The study includes three parts. In the first part, the paper analyzes modeling ideas, model description and fundamental problems of two projects portfolio. It focuses on the relationship analysis between combinatorial parameters selection and risk-return of the sole project. The study reveals that diversification effect exists with appropriate project portfolio selection, changes in the expected return and volatility of portfolio all depend on the relationship of expected growth rate and volatility between the two individual projects, correlation coefficient and the range for combination. The paper also shows that whether the value of the portfolio increases or decreases is not simply dependent on the project's positive and negative relationship. In the second part the value of projects is evaluated by using a standard real options analysis which gives two separate projects and portfolio assessment. The third part is the main research theme of this paper: dominance analysis for investment strategy. When enterprise has two separate investment opportunities and one portfolio investment opportunity, the paper analyzes the three strategies, deletes dominated strategies and proposes several suggestions for corporate investment decision under different circumstances on the basis of relationship of sole investment's risk-return and comparision of the value of the projects, by applying dominant strategy ideology, as a result of evaluation analysis for the three strategies.