Real Options: Managing Strategic Investment in an Uncertain World (Financial Management Association Survey and Synthesis Series) [Hardcover]

Martha Amram (Author), Nalin Kulatilaka (Author)

Book Description

ISBN-10: 0875848451 | ISBN-13: 978-0875848457 | Publication Date: December 15, 1998

In capital investing, as in life, you always have options. In today's extremely turbulent world, managers recognize how risky the most valuable investment opportunities often are, and how useful a flexible strategy can be. That's why they want to know all their options. Yet many current financial assessment tools fail to identify what investors can do to capitalize on future uncertain events. Martha Amram and Nalin Kulatilaka suggest a smarter new way to think about strategic investments in terms of real options. By applying options thinking--the concept behind the recent Nobel Prize-winning work on financial options--to the evaluation of nonfinancial assets, this innovative approach brings a financial market discipline to the evaluation of a company's opportunities. Using real options theory, managers can more effectively target crucial opportunities to redeploy, delay, modify, or even abandon capital-intensive projects as events unfold. Corporate executives in finances, investments, and project management should share this book with decision makers in information technology, strategic planning, corporate restructuring, venture capital, and law. Through timely case studies, the authors show managers how to use real options to evaluate investments and create exit strategies in R&D, product design, contracts, and information technology. By linking strategic vision and tactical project decisions, Real Options helps to improve capital investment planning and results.

Editorial Reviews

Amazon.com Review

Huge payoffs in business usually entail embracing lots of risk. That's the message of Real Options, by Martha Amram and Nalin Kulatilaka. The authors argue that standard models of evaluating strategic investments fail to consider the element of risk fully. "Uncertainty creates opportunities. Managers should welcome, not fear uncertainty," write Amram, a California-based consultant, and Kulatilaka, a Boston University finance professor, in describing the "real options approach." The book provides plenty of theoretical case studies, formulas, and charts that demonstrate how to shape business strategies using a system based on option-pricing. The method can value everything from undeveloped land to untried products. "With it, market leaders will understand how value is created in an uncertain environment and will know how much risk they are bearing," the authors write.

Risk is also inherently dangerous--that's an unintended lesson of Real Options. The two Nobel Prize-winning economists whose work serves as the foundation for this book--Robert Merton and Myron Scholes--were the brains behind Long-Term Capital Asset Management, the notorious hedge fund that was rescued under a plan engineered by the Federal Reserve. With that caveat in mind, business planners and managers should pursue Real Options with their eyes wide open. --Dan Ring

Review

"Real Options is an exciting, accessible introduction to one of the most useful innovations of modern finance. Filled with lively examples from various industries, the book reveals the strategic power of real options in business planning."--David G. Luenberger, Professor of Engineering-Economic Systems and Operations Research, Stanford University, and author of Investment Science

"This new book by Martha Amram and Nalin Kulatilaka provides a much-needed treatment of real options theory aimed at the practitioner. It is comprehensive, highly readable, and replete with useful examples. Every corporate finance practitioner should have a copy of Real Options on hand. --Robert S. Pindyck, Mitsubishi Bank, Professor of Applied Economics, MIT Sloan School of Management, and coauthor of Investment Under Uncertainty

"Uncertainty is the greatest risk a manager faces--and provides the greatest opportunity for creating value. This book offers a way of thinking that helps managers balance the risks with potential payoffs when making decisions in an uncertain world. The real options approach is a simple yet potent method that great leaders--military, political, and economic--use implicitly. Real Options is an excellent introduction to these concepts and their applications."--James Wall, Treasurer and Controller, AirTouch Communications

See all Editorial Reviews

Product Details

• Hardcover: 246 pages
• Publisher: Oxford University Press, USA (December 15, 1998)
• Language: English
• ISBN-10: 0875848451
• ISBN-13: 978-0875848457
• Product Dimensions: 9.1 x 6.2 x 1 inches
• Shipping Weight: 1.2 pounds (View shipping rates and policies)
• Average Customer Review: 3.0 out of 5 stars  See all reviews (23 customer reviews)
• Amazon Best Sellers Rank: #885,388 in Books (See Top 100 in Books)

Customer Reviews

Most Helpful Customer Reviews

55 of 59 people found the following review helpful:

2.0 out of 5 stars Shamelss self-promotion, May 29, 2001

By 

"cued" (San Diego, CA) - See all my reviews

This review is from: Real Options: Managing Strategic Investment in an Uncertain World (Financial Management Association Survey and Synthesis Series) (Hardcover)

This book is another good example of a phenomenon I call "Fad-peddling" at its worst. "Real Option Valuation" is just a fancy new name consultants-for-hire have made up to describe a set of problems economists like Dr. Pindyck have called "contingency claims" problems for years. Given the history of the two terms, I prefer "contingency claims", because of its record as a term used by economists in academic journals and because "real options" sounds too much to be like some new fad, like "reengineering" or "liberation management."

Most of the other reviews are absolutely right: this book seriously lacks any quantitative explanation. No need to look for kind words; this is a serious oversight. And yes, this book does read like a long sales resentation.

While the authors adequatley describe broadly how economists and financial executives solve contingency claims problems (generally using binomial methods, simulation, or partial differential equations), they don't teach any of these methods in any useful way. At best, after reading this book, you will be able to recognize whether or not your organization has any "real options".

Beyond the quantitative short-comings of this book, however, there are some flawed fundamentals about their whole approach: this book treats real options as a new finance panacea for the 1990's, and suggests that the world of finance in 20 years will be a very different place because of these revolutionary ideas. Contingency claims problems are limited to a very specific set of economic phenomena with specific criteria. If the criteria are not present, contingency claims models fall apart. Consider the amount of abuse something as well-known as the black-scholes option pricing equation is subject to when it is applied to "real options valuation": the black-scholes equation is a function of two variables, primarily: time and stock price variance. When you take this equation and try to apply it to, say, the valuation of an option to market patented drug, how do you define variance and time? Time in an option contract is fixed in the contract. Variance is empirically observable from stock prices. Plus, how do we know that the value of drug patents resembles stock prices (log-normal process)? What if it is more like the behavior of a commodity (mean-reverting process)? And where are we going to get the data from anyway? In that case, the black-scholes equation needs to be abandoned and an alternative partial differential equation needs to be developed. But who is going to do that? At what cost? Obviously, at a certain point the benefits derived from exactly modelling your options is eclipsed by the cost and effort involved in doing so. The scariest part, however, happens when you realize that the greater the variance (risk) and the longer the timeframe chosen, the greater the final value of a project or investment. Now the project manager who wants to sell ice to the eskimos has the quntitative methods available to justify such a high risk project. (Just think, the project manager could sell this project to top management as a long-term investment anticipating the melting of the polar ice caps, when the price of ice in Greenland is expected to go through the roof).

This book tries to reach too far, suggesting that phenomena which never should be valued as contingency claims can be valued as such. Real options (or contingency claims) are best treated as a very specialized set of quantitative techniques used to model very specific phenomena which a company may or may not be subject to see "Investment under Uncertainty" by Dixit and Pindyck for an inventory of those phenomena). Push the envelope too far and the paper tears as it does here.

24 of 26 people found the following review helpful:

1.0 out of 5 stars The authors lost an unique opportunity, November 27, 2000

By A Customer

This review is from: Real Options: Managing Strategic Investment in an Uncertain World (Financial Management Association Survey and Synthesis Series) (Hardcover)

The importance of the subject can't be overstated. The authors, however, are more interested in selling advice, keeping unrealistic cases without a full solution, using phrases like "We used a simple binomial model to get illustrative results". What results? Incomplete answers, however, are nothing compared to basic conceptual mistakes. In chapter 10, the authors estimate the value of an established firm using a current multiple; then, for using the B&S formula, they bring it to present value!! Want more? Just read the book...

29 of 33 people found the following review helpful:

1.0 out of 5 stars Hand-waving polemic on real options, December 26, 1999

By 

Richard Schmitt "Deputy CIO" (Tallahassee, Florida USA) - See all my reviews
(REAL NAME)   

This review is from: Real Options: Managing Strategic Investment in an Uncertain World (Financial Management Association Survey and Synthesis Series) (Hardcover)

This is a book where the faculty thinks it's doing you a favor by writing the book, handwaving through proofs, stating results, and saying the proofs are in the handouts. In this book, the handouts are the spreadsheets. On page 19 the authors state "The numerical calculations for these and other examples in this book are at out website. In my opinion, this is a bald-faced mis-statement. Some simple spreadsheets are given, but no spreadsheets are given for chapters 11, 12, 13, 14, 15, 16, 17, 18, and 19 which are 9 of the 10 chapters in Part III, 'The Portfolio of Applications.' And what are those missing topics? Just the following... Chapter 11 -- Investing in a Startup, Chapter 12 -- Exploring for Oil, Chapter 13 -- Developing a Drug, Chapter 14 -- Investing in Infrastructure, Chapter 15 -- Valuing vacant land, Chapter 16 -- Buying flexibility, Chapter 17 -- Combining real and financial flexibilty, Chapter 18 --Investing to preempt competition, and Chapter 19 --Writing a license. Yes folks, the REALLY INTERESTING subjects are MISSING those spreadsheets! What a delightful surprise! Don't buy this book until the authors pony up the missing spreadsheets on their website. (The authors may also want to place on their website the complete references for the numerous 'forthcoming' citations that litter this book.)