models.Itcan,however, bevaluedasanoption.Thesame
canbe said aboutequity ina money-losing companywith
substantialdebt;mostinvestorsbuyingthisstockarebuying
it for the same reasons they buy deep out-of-the-money
options.Second,optionpricingmodelsdoyieldmorerealistic
estimates of value for assets when there is a significant
benefit obtained from learning and flexibility. Discounted
cash flow models will understate the values of natural
resourcecompanies,wheretheobservedpriceofthenatural
resourceis a key factor in decision making.Third, option
pricingmodelsdohighlightaveryimportantaspectofrisk.
Whileriskisconsideredalmostalwaysinnegativetermsin
DCFandrelativevaluation(withhigherriskreducingvalue),
thevalueofoptionsincreasesasvolatilityincreases.Forsome
assets,atleast,riskcanbe anallyandcanbe exploitedto
generate additional value.
This isnot to suggestthat usingreal-options modelsisan
unalloyed good. Using real-options arguments to justify
paying premiums on DCF valuations when the options
argumentdoesnotholdcanresultinoverpayment.Whilewe
do not disagree with the notion that firms can learn by
observing what happens over time, this learning has value
onlyifithassomedegreeofexclusivity.Wearguelaterin
thisbookthatitisusuallyinappropriateto attachanoption
premium to value if the learning is not exclusive and
competitorscanadapttheirbehavioraswell.Therearealso
limitationsinusingoptionpricingmodelstovaluelong-term
options on nontraded assets. Theassumptions made about
constantvarianceanddividendyields,whicharenotseriously
contestedforshort-termoptions,aremuchmoredifficultto
defend when options have long lifetimes. When the
underlyingassetisnottraded,theinputsforthevalueofthe