Real Options and Product Life Cycles

Nicolas P. B. Bollen
Additional contact information
Nicolas P. B. Bollen: Department of Finance, David Eccles School of Business, The University of Utah, Salt Lake City, Utah 84112

Management Science, 1999, vol. 45, issue 5, 670-684

Abstract: In this paper, I develop an option valuation framework that explicitly incorporates a product life cycle. I then use the framework to value the real option to change a project's capacity. Standard techniques for valuing real options typically ignore product life cycle models and specify instead a constant expected growth rate for demand or price. I show that this specification can lead to significant error in the valuation of capacity options. In particular, the standard technique tends to undervalue the option to contract capacity and overvalue the option to expand capacity. This result has important implications for capital investment decisions, especially in high-technology industries that feature regular introductions of newly improved products.

Keywords: real option; product life cycle; contingent claim (search for similar items in EconPapers)
Date: 1999
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (29)

Downloads: (external link)
http://dx.doi.org/10.1287/mnsc.45.5.670 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:45:y:1999:i:5:p:670-684

Access Statistics for this article

More articles in Management Science from INFORMS Contact information at EDIRC.
Bibliographic data for series maintained by Chris Asher ().