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Risk-neutral option pricing methods for adjusting constrained cash flows.
- Article from:
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Engineering Economist
- Article date:
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March 22, 1999
- Author:
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;
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Copyright informationCOPYRIGHT 1999 Institute of Industrial Engineers, Inc. (IIE). This material is published under license from the publisher through the Gale Group, Farmington Hills, Michigan. All inquiries regarding rights should be directed to the Gale Group. (Hide copyright information)
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Standard procedures for evaluating future cash flows are to find an appropriate discount rate consistent with the cash flow's risk and then to derive a present value. While discounted cash flows seem appropriate for many instances, finding appropriate discount rates is often difficult, or discount rates may not exist when the risk is actually a function of a decision that requires the cash-flow valuation. We consider two approaches that have been suggested to alleviate this problem: the capital asset pricing model (CAPM) and the risk-neutral pricing arguments from option theory. We discuss the assumptions inherent in these models and show the results on the well-known news vendor model. Our ...
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