FUZZY REAL OPTION VALUATION MODEL USING TRINOMIAL LATTICE APPROACH AND ITS PROPERTY CONSTRUCTION INVESTMENT APPLICATION

Year 2017, , 19 - 23, 30.12.2017

Huseyin Yigit Ersen Oktay Tas

https://doi.org/10.17261/Pressacademia.2017.739

Abstract

Objective-
Decision makers usually use conventional methods in appraising investment
projects. However, nowadays, dynamic valuation models about the future of
investments also needs to be included in the decision making process. This
study aims to show that a property construction investment project, which seems
to be unprofitable with conventional methods currently, can be implemented
profitably in the future by using a fuzzy real
option method with dynamic characteristics. Using fuzzy numbers in addition to
the classical fuzzy option theory will expand the model’s scope and enable it
to contain more information, thereby making it more appropriate for investment
environments with high uncertainty.  In addition, both the
standard deviation calculated from expected value of the fuzzy numbers and the
historical volatility will be used for the fuzzy real option valuation. Thus,
it is aimed to compare the two methods. Finally, it is aimed to transfer expert
opinions to the model as well.    

Methodology-
The project valuation of a property construction investment planned to be
made in Turkey has been performed by using Trinomial Fuzzy Real Option method.
First, the volatility variable of this model was determined on the basis of
Carlsson and Fuller’s proposal of expected values and standard deviations for
fuzzy numbers. Next, the historical volatility of house price index used for
the volatility variable of the model. Finally, these two methods were compared.
The model also includes expert opinions. These expert opinions have been
transferred to the model with the aggregation of fuzzy numbers.

Findings-
According to the valuation conducted with Trinomial Fuzzy Real Options, the
property construction investment project, which seems to be unprofitable
currently, can be implemented profitably in the future. Due to the
transactional nature of fuzzy numbers, volatility value, which is calculated on
the basis of standard deviation of cash flows, will increase per annum. On the
other hand, the historical volatility is used as a constant for all investment
years. In parallel with this approach, the optimum investment year of the model
using the standard deviation of cash flows as volatility has been different the
model with historical volatility.

Conclusion- The idea of using options in investment projects adds both managerial
flexibility and uncertainty concepts to the valuation process. In addition to the term volatility, which is used for the concept of
uncertainty in the model, the naturally existent uncertainty of fuzzy numbers
is also used in the model. Furthermore, it is shown that the investment project, which seems to be
unprofitable currently, can be carried out profitably in the future with the
managerial flexibility of a delay option. While the volatility, which is
calculated on the basis of the standard deviation of cash flows, postpones the optimum investment
timing with its increasing value, the historical volatility model gives earlier
optimum investment timing. 

Keywords

Real options, property investment, fuzzy sets, net present value, investment projects, trinomial fuzzy real option valuation

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