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Binomial basis for linear information dynamics: real options, dividends and the valuation of equity

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Analytical research has confirmed that real options give rise to the kind of nonlinearities observed in practice between equity prices and the figures appearing on corporate financial statements. We develop these real option values in terms of a quasi ‘supply-side’ model of linear information dynamics based on simple discrete time binomial filtration processes. Our analysis shows that the linear models that pervade the empirical (and analytical) work of the area, will almost certainly suffer from an omitted variables problem. Parameter estimation will then be inconsistent and inefficient.

Keywords: Adaptation value; Binomial filtration; G00; Linear information dynamics; M41; Real options; Recursion value

Document Type: Research Article


Affiliations: 1: Department of Economics, University of Bristol, Bristol, BS8 1TN, UK 2: School of Business and Economics, University of Exeter, Exeter, EX4 4PU, UK 3: Business School, Loughborough University, Loughborough, LE11 3TU, UK

Publication date: November 1, 2005


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