Customer Reviews

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

5 star:		(5)
4 star:		(5)
3 star:		(4)
2 star:		(3)
1 star:		(6)

 

 

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.

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...

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.)

A very disappointing read. Although this book will explain the power of real options I feel it does a very poor job of explaining how to evaluate them. Additionally the book has errors in some of its examples and in more than one place is incorrect. (ie spread option analysis) In several places it gives some theoretical values with no explanation as to how they were reached. I would only recommend you read the 1st Chapter in each section, as subsequent chapters just repeat the material but with a different concept. Definitely not for the person looking for a book with some meat on it. (Incidently several of the 'real options' they identify in the book or completely outdated. ie The afore mentioned spread option. People haven't used the method they suggest for many years as its mathematically incorrect.)

If you are interested in learning about how to conduct option analysis, this is not the book for you. The book never provides you with the details on how to conduct the valuations described in the examples. Instead, they use over 100 pages to reiterate the same points they describe in the first 5. Furthermore, there are plenty of mistakes in the text to add to your confusion.

In short, this book is a waste of time and money.

The authors praise the real options approach as t h e new and effective method to decide on uncertain investments. When it comes to elaborate on methods and techniques, however, they fall short of explanations and try to get away just with a presentation of final results. It seems to be no more than a marketing gag. If you want to waste your money than buy the book.

For me, the book was verbose, repetitive, poorly organized. Not inspiring and not recommended.

I was rather disappointed by this book. I was hoping for something which could help explain to business managers why processes such as IT delivery are uncertain, and the value of delivering flexible solutions. The initial part of the book makes a lot of strong qualitative statements of exactly the right sort:
- There is great value in breaking up large projects in uncertain markets
- Options (flexibility) create value out of uncertain events.
- Exit options which allow you to step away from a planned path, even if relatively expensive, may have significant value.
- An option such as an exit option, can make an investment viable when it would fail a traditional NPV test.
- Small speculative investments can enable larger investments to benefit from learning and to be much more accurately targeted.
- It may create greater value to start many projects and abandon more, rather than aiming to abandon a minimum number.

Unfortunately the remainder of the book then supports these statements only for a very limited set of circumstances. The Real Options approach only seems to work if the option can be translated into (or at least mapped onto) a tradeable financial security. There's no real attempt to provide tools to evaluate internal uncertainty, such as the delivery uncertainty common in IT projects, or the value of flexibility except where it maps to significant investment decisions.

The book does do a good job of explaining that real world situations are non-linear, with value which changes as a result of natural volatility, over time, and as a result of one or more decisions. Traditional NPV-based approaches greatly undervalue flexibility, insurance, learning and platform investments, and can't really deal with this non-linear aspect. Simply increasing the investment discount rate, which is the usual way of dealing with such problems, doesn't bring the correct focus onto uncertainty and total risk.

However, the mathematical basis for Real Option valuation is not well explained, and I found the processes difficult to follow. I suspect that the authors implicitly assumed a certain familiarity with economic and financial market techniques and terminology, which limits the value of this book to those seeking, as I was, to apply the techniques to other fields. It also left me puzzled as to why simpler approaches, such as Decision Tree techniques, can't be used instead.

Surprisingly for a relatively short book the text is very repetitive, and too often turns into a blatant advert for the Real Options approach compared with others, rather than making the case on its own merits.

Hindsight is a great thing, but it is unfortunate that this book praises Enron as an example of success through options manipulation, where we now know this was largely a "long company" scam. Some of the other examples, quoted at the height of the Internet boom, have also not stood the test of time. However, these should not be seen as invalidating the approach, merely as evidence of how uncertain things may really be.

This book provides some good ideas, and if your focus is major business-critical financial transactions it may be very useful. But I'm still looking for a good book on how to generically value flexibility.

The only saving grace about this book is that it is readable. However, the reason for this is because there is not much to learn about RO from this book. The author's talk about numerous examples and the "concept" of how RO was applied. But, you will not learn the actual process of using RO, unlike Copeland's or Trigeorgis' book.

This is the first Real Options book that targets the general management audience and, subsequently, is not bursting at the seams with daunting calculations and formulas that typically turn-off even the most enthusiastic readers. It recognizes that there is just as much power in developing a 'real options way of thinking' as there is in understanding the mechanics of the economic theory. Having worked for several years in product development where traditional financial treatments like NPV are extremely limited, I cannot emphasize enough the power of these frameworks. I would highly recommend this book to people who are similarly frustrated by their current managmement tools which fail to capture the nuances of the strategic decisions they face. Through its structure and frequent case examples, the book makes real options much more approachable. This increases the likelihood that decisions will actually be influenced and enhanced even in the face of significant uncertainty.