An Improvement And Applied Research Of The Multi-stage Compound Option Pricing Model

Compound option plays an important role in evaluating a project’s valuation andbecomes a focus of academic gradually. Compared with Net Present Value, compoundoption adopting the point of financial option, considers the flexibility of investmentmanagement, which dealing with the uncertainty at the project development well.Therefore, compound option’s theory and method are richly endowed with theinvestment decision-making, especially with multistage investment decision analysis.The thesis studies the multi-stage compound option pricing problem. Compoundoption is a periodic consecutive process, which consist of several stage,and virtuallyeach stage is executing the next stage’s the option value. Firstly, we give a new proofof the two stage model, which mainly adopting the opinion of two-dimensionaldistribution function deduced from one-dimensional standard normal distributionfunction. Then, in the traditional multi-stage compound option model, it assumesvolatility is a constant, that does not coincide with the actual situation. To address thisshortcoming we introduced a variable volatility, i.e. the improved three-stage variablevolatility compound option pricing model, and find the corresponding closed formsolution. The improved compound option model considers how to deal with theeffects of risk coming from each stage, which is neglected by traditional method.This thesis is based on the six stage compound option model used in the medicineevaluation project. In each stage,based on the success probability generated fromvarious risks, the Poisson distribution and analytic hierarchy process were used toestimate the probabilities. Finally, we obtained the improved six stage compoundoption pricing model and it’s closed solution.At the end of this thesis, we use the improved six-stage compound option modelto evaluate new drug R&D projects. The result illustrates the rationality andsuperiority of the improved model. Moreover, because of the complexity of the higherstage of the option pricing model, it becomes very difficult for practitioners to use,and then blocked development of this method. And we provide a simple calculationprocedure for the multi-stage compound option model, which has a inclusive research in many fields.