Investment under uncertainty and volatility estimation risk

Abstract

This article considers the implications of volatility estimation risk in real options theory. We construct confidence intervals for critical project values and options prices. An empirical example in lease investment evaluation for an offshore petroleum tract shows that confidence intervals can be substantial when a limited amount of data are used to estimate volatility.

Keywords:

• real options
• estimation risk
• investment evaluation
• volatility
• offshore petroleum tract

JEL Classification:

• C44
• D81
• G31
• Q30

Acknowledgements

The authors are grateful to Eduardo Schwartz, Graham Davis and Apostolos Kourtis for their useful comments and suggestions. George Dotsis acknowledges financial support from the ‘IRAKLITOS’ Research Fellowship Program financed by the Greek Ministry of Education and the European Union. The usual disclaimer applies.