Mean Reversion with Drift and Real Options in Steel Industry

Luiz de Magalhães Ozorio (), Carlos de Lamare Bastian-Pinto (), Tara Nanda Baidya () and Luiz Eduardo Teixeira Brandão ()
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Luiz de Magalhães Ozorio: Ibmec Business School
Carlos de Lamare Bastian-Pinto: Unigranrio University
Tara Nanda Baidya: Pontifical Catholic University of Rio de Janeiro (PUC-Rio)

Brazilian Review of Finance, 2012, vol. 10, issue 2, 215-241

Abstract: Steel is a commodity with significant price volatility and the choice of stochastic process that better describes its price performance is a fundamental issue in real options valuation in steel industry projects. As verified with other commodities, it is assumed that steel prices can be led partially by a mean reversion component, but the analysis of some economic issues related to production indicates that steel prices may also have a rising drift component. This, in practical terms, would increase the long term mean with time. This work presents a model that we call Mean Reversion with Drift (MRM-D), in which a deterministic tendency is attached to the long term equilibrium level in order to capture the increase of steel production marginal cost. It then evaluates the implications of using this model in valuation of steel sector projects.

Keywords: stochastic processes; real options; mean reversion models; steel industry (search for similar items in EconPapers)
JEL-codes: C61 L61 M21 (search for similar items in EconPapers)
Date: 2012
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Persistent link: https://EconPapers.repec.org/RePEc:brf:journl:v:10:y:2012:i:2:p:215-241

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