By Max Schöne
The writer indicates that modelling the doubtful money stream dynamics of an funding undertaking merits cautious realization in actual strategies valuation. targeting the case of commodity expense uncertainty, a vast empirical learn finds that, opposite to universal assumptions, costs are usually non-stationary and express non-normally dispensed returns. in this case, extra life like stochastic volatility, bounce diffusion, and Lévy tactics are evaluated within the context of a stylised funding venture. The valuation effects recommend that stochastic method selection could have mammoth implications for valuation effects and optimum funding rules.
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The writer indicates that modelling the doubtful money circulate dynamics of an funding venture merits cautious consciousness in genuine strategies valuation. targeting the case of commodity cost uncertainty, a huge empirical research unearths that, opposite to universal assumptions, costs are frequently non-stationary and convey non-normally allotted returns.
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Additional resources for Real Options Valuation: The Importance of Stochastic Process Choice in Commodity Price Modelling
However, using 3IQR instead, skewness remains present particularly for measure S1. In any case, these ﬁndings are surprising since they contradict the popular idea of commodities’ positive exposure to supply shocks, which would lead us to expect a generally positive skewness throughout all cases. Turning to the results for excess kurtosis, all metrics indicate values above normal. Even after outlier management this result is weakened, but leads to the same conclusion. This is little surprising given the extreme price swings observed in past 28 data.
In fact, when considering the price peak on 11/07/2008 and the corresponding model price distributions, it stands out that observations of this kind (or above) have zero probability in the Vasicek model but 13 per cent under GBM. If we imagine now a hypothetical ﬁrm assessing the value of a natural hedge against high aluminium prices such as a production facility that allows to switch to a different, less costly input resource in times of high aluminium prices, it becomes clear that the inherent option to switch21 would have been undervalued on the basis of assuming mean reversion in prices.
In this section, the aim is to understand what factors cause these fat tails in return distributions so that we can come up with realistic stochastic processes that can mimic historical distributions. Fortunately, the list of possible ways to model fat tails and generally excess kurtosis in stochastic processes is not long. , 2007; Schoutens, 2003). In order to see which of these features is likely to work behind the scenes of commodity returns, we will consider both possibilities in some more detail hereafter.
Real Options Valuation: The Importance of Stochastic Process Choice in Commodity Price Modelling by Max Schöne