Compound Real Option Valuation with Phase Specific Volatility: A Multi Phase Mobile Payments Case Study
Multi staged R&D projects are copy book cases of compound real options. Traditional compound option models assume a constant volatility over the lifetime of the project. Building on the n fold compound option model of Cassimon et al. (2004) we extend this model to allow for phase specific volatility estimates, while preserving the closed form solution of the model. We illustrate the extended model with a case study of a real option valuation of a multi stage software application project by a large mobile phone operator and we show how project managers can estimate phase specific volatilities.