Real options and isoelastic utility functions model: the case of valuation a R&D project in incomplete markets

Real options and isoelastic utility functions model: the case of valuation a R&D project in incomplete markets

Abstract:

The real options models are a powerfull tool for valuating assets like patents, technologicals developments, intangles, strategies, and TBF or closed firms in development markets. Its theorethical foundations are based on the existences of completed markets and neutral risk valuation; the premises that are not verified on the valuation for the indicated assets class in emerging markets.

The paper proposes a model that incoporates the risk preferences with isoelastics utility functions (CRRA) in the binomial model, dispensing of the risk neutral valuation concept. First the main notions are shown over: utility functions, risk aversion coefficients and isoelastic utility function.
Then, the group of ecuations related to the model is developed, applying them over a biofarmaceutical project with secuencial options and at the same time, risk aversión coefficient’s sensitivity analysis with the option value. Finally the main conclusions are shown.

Keywords: Real Options, Isoelastic Utility Function, Risk Aversion Coefficient. Jel Code: G30, G32.