A Note : Are (Positive) Real Options Values a Contradiction in Terms?

Claiming analogy with financial option pricing the real options approach assumes that the present value of investment cash flows (or: real asset value) can be replicated by a risk-free financial portfolio; that is, this present value is considered to be equivalent to an asset value in a complete capital market. It would be perfectly legitimate to ask whether the complete market assumption, which is the fundamental base of option pricing theory, also holds for real assets. This note, however, does not investigate the arbitrary question whether the assumptions of the real options approach are adequate. It asks the more fundamental question whether non-zero real option values are consistent with the very model assumptions. We demonstrate that this is not the case. Our systematic review of model assumptions refutes the widespread opinion that so called real options can be valued independent of subjective risk preferences. Consequently we have to conclude that, though computed real asset values may reflect flexibility, they never represent option values in line with option pricing theory