Valuation of Two-Stage Contraction Options with the American Exercise Right: A Discontinuous Galerkin Approach

Result code in IS VaVaI
<a href="https://www.isvavai.cz/riv?ss=detail&h=RIV%2F61989100%3A27510%2F25%3A10257855" target="_blank" >RIV/61989100:27510/25:10257855 - isvavai.cz</a>
Result on the web
<a href="http://dx.doi.org/10.1063/5.0246030" target="_blank" >http://dx.doi.org/10.1063/5.0246030</a>
DOI - Digital Object Identifier
<a href="http://dx.doi.org/10.1063/5.0246030" target="_blank" >10.1063/5.0246030</a>

Result language
angličtina
Original language name
Valuation of Two-Stage Contraction Options with the American Exercise Right: A Discontinuous Galerkin Approach
Original language description
Determining the true profitability of investment opportunities is essential in decision-making. This is particularly typical for sequential investments that follow a specific order. This study focuses on a specific type of sequential investment, known as a compound option to contract. When applying the real options approach, the values of investments projects are governed by a relevant partial differential equation of two variables: time and output commodity price, which follows a relevant stochastic process. As the investment project’s flexibility is similar to an American-style put on put option, traditional valuation techniques of conventional financial options can be easily applied. In order to improve the numerical evaluation procedure, we employ a semi-implicit time stepping scheme together with a discontinuous Galerkin approach for spatial discretization, incorporating a penalty technique to handle the early exercise constraint. We follow a backward induction, beginning with the finished project, calculating the values of the option to contract in the second stage and in the first stage (subsequently) to find a present value of the compound option. Finally, the proposed numerical scheme is applied to a simple conceptual decision-making problem.
Czech name
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Czech description
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Project
<a href="/en/project/GA22-17028S" target="_blank" >GA22-17028S: Flexible tools for strategic investments and decision-making: analysis, valuation and implementation</a><br>
Continuities
P - Projekt vyzkumu a vyvoje financovany z verejnych zdroju (s odkazem do CEP)

Publication year
2025
Confidentiality
S - Úplné a pravdivé údaje o projektu nepodléhají ochraně podle zvláštních právních předpisů

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