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Table of contents
1. Estimating Changing Volatility in Cash Flow Simulation Based Real Option Valuation with Regression
Sum of Squares Error Method.........................................................................................................................

Bibliography...................................................................................................................................................... 3

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Estimating Changing Volatility in Cash Flow Simulation Based Real Option Valuation with Regression
Sum of Squares Error Method
Author: Haahtela, Tero J.

1 1

Aalto University

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Abstract: This paper presents a practical volatility estimation method for cash flow simulation based real option
valuation with changing volatility. During cash flow simulation, present value of the future cash flows and their
corresponding cash flow state variable values are recorded for all time periods. Then, for each time period,
regression analysis is used for relating the present value to the cash flow state variables of the same time
period. Each regression equation provides an estimate of the expected present value as a function conditioned
on the resolution of all uncertainties up to that time. Then, basic regression statistics of Pearsons correlation R2
and sum of squares error (or standard error) for each equation provide all the information required for estimating
how the standard deviation and volatility of the stochastic process change over time. The method is
computationally efficient because it requires only one pass of simulation runs regardless of the number of time
periods. It can also handle negative underlying asset values. Straightforward calculation of required regression
statistics and their availability in any statistical software and even in spreadsheet programs make this approach
very easy to apply for a practitioner.
Links: Link to full text
Subject: Studies; Present value;
Classification: 9130: Experimental/theoretical; 3100: Capital & debt management
Identifier / keyword: Financial Economics Network, Economics Research Network, Management Research
Network, FEN Subject Matter eJournals, ERN Subject Matter eJournals, Corporate Finance eJournals,
Econometrics eJournals
Publication title: SSRN Working Paper Series
Publication year: 2011
Publication date: Jun 2011
Year: 2011
Publisher: Social Science Research Network
Place of publication: Rochester
Publication subject: Social Sciences: Comprehensive Works
Source type: Working Papers
Language of publication: English
Document type: Working Paper
DOI: http://dx.doi.org/10.2139/ssrn.1864905
ProQuest document ID: 1095325432
Document URL: http://search.proquest.com/docview/1095325432?accountid=143338
Copyright: Copyright Social Science Research Network Jun 2011

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Last updated: 2012-10-09


Database: ABI/INFORM Global

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Bibliography
Citation style: Harvard
Estimating Changing Volatility in Cash Flow Simulation Based Real Option Valuation with Regression Sum of
Squares Error Method 2011, , Social Science Research Network, Rochester.

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