Study On Compound Option Pricing Model Based On Graph Theory

Discounted Cash Flow method (DCF) is the most widely used method of project appraisal and physical assets investment decision-making process. With the development of new technologies and the strengthening of the trend of globalization, we found that decision-makers need to make some important strategic investment decisions in a very uncertain environment. Under such circumstances, there are certain defects of the traditional investment decision-making tools. Using traditional investment tools to assess the results often leads to the accuracy of the assessment results, which could lead to the loss of investment opportunities. The biggest shortcoming of Discounted Cash Flow method is that the management flexibility was ignored. Real Options is thinking of financial options in the field of physical and promotion.Since the first time the concept of real options was created by Myers , analysts and investors showed great interest in Real Options. In the past 20 years, on the kind of options research has made great progress. Along with the popularization and application of the in-depth study , there has been growing recognition that the most of real options in the reality of economic life is compound options. Although compound Option theory has broad application prospects ,due to the complexity of the existing real option pricing method, as well as the lack of a strong visual to the conditions and other factors. This approach has led to the use limitations.Existing quantitative analysis method of real options can be divided into two categories : One is a continuous method ,such as the Black-Scholes option pricing model. The other is a discrete method, such as the binomial tree option pricing methods. Other methods are based on the expansion of these two methods. And the complexity of calculation of these two methods and strict hypothesis, the actual application process with a certain degree of difficulty.In this paper, we study on the basis of Cox, Ross & Rubinstein, Trigeorgis,Fischer Black and Myron Scholes and others . First of all ,we reviewed the compound option pricing theory and the investment literature. And then ,we made a qualitative study on compound option theory , including the concept of compound options, characteristics of the compound options, the value of options composite decision mechanism, the value function of compound option, classification of the compound options, and the complex interaction of compound options. Next we reviewed some of the existing options pricing model to make a comparative study of the system. These include commonly used Black-Scholes option pricing model, binomial tree option pricing model, trinomial Option Pricing Model, Geske compound option pricing model and the Monte Carlo simulation method which is not very commonly used. By comparison study to describe why these methods are not suitable to conduct compound option pricing. Discussed these option pricing method in the application process, and their advantages and disadvantages.Comprehensive review the above options pricing method we found these methods in dealing with compound options pricing exist more or less difficult. Therefore, We need to combine the characteristics of physical assets and the complex nature of complex real options in the process of option pricing, to find a more general application can also have a more practical approach.Chapter IV, we give a new compound options pricing model based on the classical method of binomial tree options pricing method. This approach integrates the advantages of decision tree and the binomial tree. To be able to more accurately calculate the value of complex options. For the unresolved individual risk and market risk facing the investment projects with a more extensive analysis of the applicability of real options .This new model less than a classical binomial tree method is more flexible and more widely constraints applicability.By study on this method ,we found that this method can properly solve the underlying assets at the risk of facing mixed situation. The results show : When compound options facing the market risk, they can use risk-neutral approach to do it. In the process of pricing we should make the appropriate adjustments timely. When compound options facing the individual risk, or combination of market risk and indicidual risk or need to use subjective probability. Since then not meet the risk-neutral and non-arbitrage hypothesis, no longer apply the traditional tree pricing methods. At this time , we can use the compound option pricing model we introduced in this paper.