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Encyclopedia of Law and Economics pp 1778–1787Cite as

Real Options

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Definition

The incorporation and valuation of operational flexibility and of strategic value of investments in the decision-making process under uncertainty. The option nature of the investment decision arises from the coexistence of uncertainty, irreversibility, and timing flexibility and allows reaping upside potential while insulating from downside risk.

Introduction

The decision to allocate resources to investment opportunities is traditionally evaluated using a net present value (NPV) approach for private sector projects or a cost-benefit approach for public sector projects. Typically, it sums all the incoming and outgoing cash flows over the lifetime of a project, each discounted at an appropriate risk-adjusted discount rate to derive its present value. The latter is compared with the (current) initial investment cost needed to start the project. In case the outcome of this comparison renders a positive result, one decides to invest; in the other case, one rejects the project....

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Author information

Authors and Affiliations

  1. Utrecht School of Economics (USE), Utrecht University, Utrecht, The Netherlands

    Peter-Jan Engelen

  2. Faculty of Business and Economics, University of Antwerp, Antwerpen, Belgium

    Peter-Jan Engelen

  3. Institute of Development Policy and Management (IOB), University of Antwerp, Antwerp, Belgium

    Danny Cassimon

Authors
  1. Peter-Jan Engelen
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  2. Danny Cassimon
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Corresponding author

Correspondence to Peter-Jan Engelen .

Editor information

Editors and Affiliations

  1. MRE and University of Montpellier, Montpellier, France

    Alain Marciano

  2. Faculté d’Economie, Université de Montpellier and LAMETA-UMR CNRS, Montpellier, France

    Alain Marciano

  3. DiGSPES, University of Eastern Piedmont, Alessandria, Italy

    Giovanni Battista Ramello

  4. IEL, Torino, Italy

    Giovanni Battista Ramello

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Engelen, PJ., Cassimon, D. (2019). Real Options. In: Marciano, A., Ramello, G.B. (eds) Encyclopedia of Law and Economics. Springer, New York, NY. https://doi.org/10.1007/978-1-4614-7753-2_406

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