Valuing Flexibility as a Complex Option

This paper develops an approach for valuing flexible production systems using contingent claims pricing. Demand curves for the authors' model's underlying assets (output products) may be downward sloping, in contrast with the standard option pricing assumption. Also, their marginal production (exercise) costs may be increasing. In addition, they allow for multiple products and a productions capacity constraint. These elements of the model result in complex exercise decisions for the contingent claims that comprise the production system's value. The authors illustrate their approach by valuing a flexible system that produces two products that have profit margin functions with stochastic parameters. Copyright 1990 by American Finance Association.

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