Ambiguity Aversion - Ambiguity Aversion in Real Options

Ambiguity Aversion in Real Options

Real option valuation has traditionally been concerned with investment under project value uncertainty while assuming the agent has perfect confidence in a specific model. The classical model of McDonald and Siegel developed quantitative methods used to analyze the options. They investigate the problem from the approach of derivative pricing and assign the value of the option to invest as The expected value is taken under an appropriate risk-adjusted measure, I is the cost of investing in the project, Pt is the value of the project at time t and T denotes the family of allowed stopping times in . In the European case, the agent may invest in the project only at maturity, in the Bermudan case, the agent may invest at a set of specific times (e.g. monthly), and in the American case, the agent may invest at any time. As such, the problem is in general a free boundary problem in which the optimal strategy is computed simultaneously with the option's value. (Jaimungal)

Note that it is not the same as risk aversion, since it is a rejection of types of risk based in part on measures of their certainty, not solely on their magnitude.