presentation at ut vince ,
i appreciate your response to my request for you to speak to my
class on real options . i thought you might enjoy the following exchange of
emails that occurred yesterday . perhaps some of these issues could be
addressed in your talk .
jim
- - - - - original message - - - - -
from : sheridan titman
sent : friday , march 31 , 2000 9 : 11 am
to : jim dyer
subject : re : real options course feedback
jim :
your student has raised some difficult questions . i would recommend ehud ,
but i thought that the finance people have the answers in cases with
complete markets and that we rely on the decision science people for cases
with incomplete markets .
if it would help , i can come in at 6 pm after my class in a couple of weeks .
sheridan
sheridan titman
department of finance
college of business administration
university of texas
austin , texas 78712 - 1179
512 - 232 - 2787 ( phone )
512 - 471 - 5073 ( fax )
titman @ mail . utexas . edu
- - - - - original message - - - - -
from : jim dyer
sent : thursday , march 30 , 2000 4 : 37 pm
to : sheridan titman
subject : re : real options course feedback
sheridan ,
which of your classes do you want to miss ? just kidding . actually
you probably told me that before . can you suggest someone else who would be
a good choice to discuss the use of option theory in the context of
incomplete markets , and to address some of the types of questions raised in
the note from the student ?
jim
- - - - - original message - - - - -
from : sheridan titman
sent : thursday , march 30 , 2000 5 : 58 pm
to : jim dyer
subject : re : real options course feedback
jim :
i teach at the same time as you do .
sheridan
sheridan titman
department of finance
college of business administration
university of texas
austin , texas 78712 - 1179
512 - 232 - 2787 ( phone )
512 - 471 - 5073 ( fax )
titman @ mail . utexas . edu
- - - - - original message - - - - -
from : jim dyer
sent : thursday , march 30 , 2000 11 : 32 am
to : sheridan titman
subject : fw : real options course feedback
sheridan ,
see the comments below . i don ' t mean to put you on the spot , and
have not announced anything in class , but i am hoping that you could visit
my class for about an hour one thursday afternoon to discuss your views
regarding applications of option pricing concepts to " real options " . as a
reminder , i ' ve attached a course outline . chris kenyon from schlumberger is
speaking on april 13 , and vince kaminski has tentatively agreed to speak on
april 20 .
i am going to be out of town on april 27 , so that leaves either next
thursday ( april 6 ) or may 4 . would either of those times work for you ? i ' m
not thinking of any preparation , but more of an informal discussion of the
" philosophical issues " related to real options work .
jim
- - - - - original message - - - - -
from : jim dyer
sent : thursday , march 30 , 2000 1 : 24 pm
to : ' jclevenger @ optionii . bus . utexas . edu '
subject : re : real options course feedback
josh ,
some very thoughtful observations . as you know , i had invited one
finance professor to our class on arundel , but he was out of town . i do
plan to invite sheridan titman to discuss the issue of using the option
models in situations where there is no underlying security that is traded .
i do think it is important to face that issue , which is actually covered at
a theoretical level in our last couple of readings .
the issue of volatility is also an excellent issue for further
discussion , as you suggest . so far , we ' ve been looking at cases where
volatility is " given " . the problem of finding an " objective " measure of
volatility for a project reminds me of the problem of finding the correct
risk adjusted discount rate , which is not surprising since the concepts are
almost two sides of the same plate . one approach , of course , is to do some
modeling using traditional decision analysis tools , including subjective
probabilities , but the finance people who write options articles don ' t like
to think about such ideas .
i ' ll try to address these issues in more detail as the semester
continues . i think it was important to surface some of these points early ,
and to come back to them after we have seen how to apply the methods in a
naive sort of way .
thanks for the feedback and comments .
jim
- - - - - original message - - - - -
from : jclevenger @ optionii . bus . utexas . edu
sent : thursday , march 30 , 2000 8 : 42 am
to : jim . dyer @ bus . utexas . edu
cc : josh - clevenger @ reliantenergy . com
subject : real options course feedback
after overcoming the initial ( i hope ) overload of materials and tools
presented
thus far in the semester , it appears to me that you are achieving the
objective
of making us comfortable with optionality valuation as applied to a variety
of
problems which are outside the borders defined by a liquid market of traded
financial elements .
as a constructive feedback , you have been forthright with us in marking off
areas of this subject which are still controversial . i also realize that
rightly so , real - world application of this type of analysis without a robust
understanding of finance may degenerate into a succession of assumptions
that
result in a " house of cards " effect . my opinion at this point is that two
issues are of potentially " make - or - brake " importance if i am to persuade my
superiors to accept these methods for valuations outside the realm of
projects
whose value is primarily driven by the value of commodities backed by
financial
instruments . these issues are easy to guess :
1 ) discounting and risk free rates : i do not sense that anyone in the
class
has put forth convincing arguments as to the proper application of time
value
questions in the absence of liquidity . is there someone within the finance
department that can present a firmer position on this question ?
2 ) volatility : i found winston ' s examples on this metric succinct . i would
recommend that in future years you dedicate some hours of class time to this
subject . my criticism again relates to messy problems . i anticipate
arguments
against real option applications based on the dispute of volatility
measures .
if i were a conservative financial manager , i would argue that :
* * * two - a : implied volatility derived from an industry specific slice of
equity
options is a shotgun approach - - the projects being valued are of a tranche
which may in fact have a significantly different outcome variance than the
weighted average measured by the equities utilized . oil , gas and electricty
are
good examples the major players are competing on many different levels of
the
value chain . smaller companies do exist which are dedicated to one strata ,
but
what about projects that want to exploit opportunies across strata in a
vertically integrated company ?
* * * two - b : based on the following skepticism - if a real option value is
being
proposed for a new business venture ( some new unexploited opportunity , )
there is
some paradox embedded in the increased value based on high volatility in new
ventures and the high risk of failure . this skepticism is likely to be less
acute in high - tech sectors where the huge upside of new ventures is paraded
before us daily by nasdq touts . it is a much harder sell to " mature "
industries .
of particular interest in the power industry are investments centered around
opportunities arising from restructuring of electricity and natural gas
sectors
as regulation is removed . a large proportion of the risk is embedded in
ongoing
changes of public policy on an international basis . as an intentionally
screwed - up example , can anyone other than a financial genius correctly asses
volatility for u . s . companies investing in seed projects in mexico based on
speculation of the inevitable dismantling of the national utility ( cfe ) and
pemex ?
james s . dyer
fondren centennial chair in business
department of management science and information systems
cba 5 . 202
the university of texas at austin
austin , texas 78712 - 1175
email : j . dyer @ bus . utexas . edu
telephone : 512 - 471 - 5278
fax : 512 - 471 - 0587
presentation at ut
vince ,
i appreciate your response to my request for you to speak to my
class on real options . i thought you might enjoy the following exchange of
emails that occurred yesterday . perhaps some of these issues could be
addressed in your talk .
jim
- - - - - original message - - - - -
from : sheridan titman
sent : friday , march 31 , 2000 9 : 11 am
to : jim dyer
subject : re : real options course feedback
jim :
your student has raised some difficult questions . i would recommend ehud ,
but i thought that the finance people have the answers in cases with
complete markets and that we rely on the decision science people for cases
with incomplete markets .
if it would help , i can come in at 6 pm after my class in a couple of weeks .
sheridan
sheridan titman
department of finance
college of business administration
university of texas
austin , texas 78712 - 1179
512 - 232 - 2787 ( phone )
512 - 471 - 5073 ( fax )
titman @ mail . utexas . edu
- - - - - original message - - - - -
from : jim dyer
sent : thursday , march 30 , 2000 4 : 37 pm
to : sheridan titman
subject : re : real options course feedback
sheridan ,
which of your classes do you want to miss ? just kidding . actually
you probably told me that before . can you suggest someone else who would be
a good choice to discuss the use of option theory in the context of
incomplete markets , and to address some of the types of questions raised in
the note from the student ?
jim
- - - - - original message - - - - -
from : sheridan titman
sent : thursday , march 30 , 2000 5 : 58 pm
to : jim dyer
subject : re : real options course feedback
jim :
i teach at the same time as you do .
sheridan
sheridan titman
department of finance
college of business administration
university of texas
austin , texas 78712 - 1179
512 - 232 - 2787 ( phone )
512 - 471 - 5073 ( fax )
titman @ mail . utexas . edu
- - - - - original message - - - - -
from : jim dyer
sent : thursday , march 30 , 2000 11 : 32 am
to : sheridan titman
subject : fw : real options course feedback
sheridan ,
see the comments below . i don ' t mean to put you on the spot , and
have not announced anything in class , but i am hoping that you could visit
my class for about an hour one thursday afternoon to discuss your views
regarding applications of option pricing concepts to " real options " . as a
reminder , i ' ve attached a course outline . chris kenyon from schlumberger is
speaking on april 13 , and vince kaminski has tentatively agreed to speak on
april 20 .
i am going to be out of town on april 27 , so that leaves either next
thursday ( april 6 ) or may 4 . would either of those times work for you ? i ' m
not thinking of any preparation , but more of an informal discussion of the
" philosophical issues " related to real options work .
jim
- - - - - original message - - - - -
from : jim dyer
sent : thursday , march 30 , 2000 1 : 24 pm
to : ' jclevenger @ optionii . bus . utexas . edu '
subject : re : real options course feedback
josh ,
some very thoughtful observations . as you know , i had invited one
finance professor to our class on arundel , but he was out of town . i do
plan to invite sheridan titman to discuss the issue of using the option
models in situations where there is no underlying security that is traded .
i do think it is important to face that issue , which is actually covered at
a theoretical level in our last couple of readings .
the issue of volatility is also an excellent issue for further
discussion , as you suggest . so far , we ' ve been looking at cases where
volatility is " given " . the problem of finding an " objective " measure of
volatility for a project reminds me of the problem of finding the correct
risk adjusted discount rate , which is not surprising since the concepts are
almost two sides of the same plate . one approach , of course , is to do some
modeling using traditional decision analysis tools , including subjective
probabilities , but the finance people who write options articles don ' t like
to think about such ideas .
i ' ll try to address these issues in more detail as the semester
continues . i think it was important to surface some of these points early ,
and to come back to them after we have seen how to apply the methods in a
naive sort of way .
thanks for the feedback and comments .
jim
- - - - - original message - - - - -
from : jclevenger @ optionii . bus . utexas . edu
sent : thursday , march 30 , 2000 8 : 42 am
to : jim . dyer @ bus . utexas . edu
cc : josh - clevenger @ reliantenergy . com
subject : real options course feedback
after overcoming the initial ( i hope ) overload of materials and tools
presented
thus far in the semester , it appears to me that you are achieving the
objective
of making us comfortable with optionality valuation as applied to a variety
of
problems which are outside the borders defined by a liquid market of traded
financial elements .
as a constructive feedback , you have been forthright with us in marking off
areas of this subject which are still controversial . i also realize that
rightly so , real - world application of this type of analysis without a robust
understanding of finance may degenerate into a succession of assumptions
that
result in a " house of cards " effect . my opinion at this point is that two
issues are of potentially " make - or - brake " importance if i am to persuade my
superiors to accept these methods for valuations outside the realm of
projects
whose value is primarily driven by the value of commodities backed by
financial
instruments . these issues are easy to guess :
1 ) discounting and risk free rates : i do not sense that anyone in the
class
has put forth convincing arguments as to the proper application of time
value
questions in the absence of liquidity . is there someone within the finance
department that can present a firmer position on this question ?
2 ) volatility : i found winston ' s examples on this metric succinct . i would
recommend that in future years you dedicate some hours of class time to this
subject . my criticism again relates to messy problems . i anticipate
arguments
against real option applications based on the dispute of volatility
measures .
if i were a conservative financial manager , i would argue that :
* * * two - a : implied volatility derived from an industry specific slice of
equity
options is a shotgun approach - - the projects being valued are of a tranche
which may in fact have a significantly different outcome variance than the
weighted average measured by the equities utilized . oil , gas and electricty
are
good examples the major players are competing on many different levels of
the
value chain . smaller companies do exist which are dedicated to one strata ,
but
what about projects that want to exploit opportunies across strata in a
vertically integrated company ?
* * * two - b : based on the following skepticism - if a real option value is
being
proposed for a new business venture ( some new unexploited opportunity , )
there is
some paradox embedded in the increased value based on high volatility in new
ventures and the high risk of failure . this skepticism is likely to be less
acute in high - tech sectors where the huge upside of new ventures is paraded
before us daily by nasdq touts . it is a much harder sell to " mature "
industries .
of particular interest in the power industry are investments centered around
opportunities arising from restructuring of electricity and natural gas
sectors
as regulation is removed . a large proportion of the risk is embedded in
ongoing
changes of public policy on an international basis . as an intentionally
screwed - up example , can anyone other than a financial genius correctly asses
volatility for u . s . companies investing in seed projects in mexico based on
speculation of the inevitable dismantling of the national utility ( cfe ) and
pemex ?
james s . dyer
fondren centennial chair in business
department of management science and information systems
cba 5 . 202
the university of texas at austin
austin , texas 78712 - 1175
email : j . dyer @ bus . utexas . edu
telephone : 512 - 471 - 5278
fax : 512 - 471 - 0587