Real options with synergies: static versus dynamic policies

M Nishihara
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M Nishihara: Osaka University, Osaka, Japan

Journal of the Operational Research Society, 2012, vol. 63, issue 1, 107-121

Abstract: We develop a model for determining whether a firm should exercise two real options individually or simultaneously. The simultaneous exercise of both options has synergy of cost savings, while the separate exercise of each option benefits from project flexibility. This trade-off determines the optimal exercise policy. We compare static and dynamic management of multiple real options. A firm under static management determines the type of exercise of real options ex ante; on the other hand, a firm under dynamic management makes the decision at the time of exercise. We show that highly correlated projects increase the option values under both styles of management because a firm is more likely to enjoy the synergy gains of joint investment. We also highlight the advantage of dynamic management over static management for weakly correlated projects.

Date: 2012
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