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Valuation of IT Investments Using Real Options Theory

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Abstract

Real Options Theory is often applied to the valuation of IT investments. The application of Real Options Theory is generally accompanied by a monetary valuation of real options through option pricing models which in turn are based on restrictive assumptions and thus subject to criticism. Therefore, this paper analyzes the application of option pricing models to the valuation of IT investments. A structured literature review reveals the types of IT investments which are valued with Real Options Theory in scientific literature. These types of IT investments are further investigated and their main characteristics are compared to the restrictive assumptions of traditional option pricing models. This analysis serves as a basis for further discussion on how the identified papers address these assumptions. The results show that a lot of papers do not account for critical assumptions, although it is known that the assumptions are not fulfilled. Moreover, the type of IT investment determines the criticality of the assumptions. Additionally, several extensions or adaptions of traditional option pricing models can be found which provide the possibility to relax critical assumptions. Researchers can profit from the results derived in this paper in two ways: First, it is demonstrated which assumptions can be critical for various types of IT investments. Second, extensions of option pricing models that relax critical assumptions are introduced.

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Notes

  1. Here, the assumptions of the BSM are listed although only assumption (A2) differs from the assumptions of the BM. But if the time intervals of the BM are scaled down, the binomial process of the BM can be converted to the continuous process of the BSM (Trigeorgis 1996, p. 83).

  2. Assumption (A5) will not be further considered since it is not ROT-specific but rather necessary for several capital market models (as, e.g., the Capital Asset Pricing Model).

  3. For the derivation of the formulas necessary for option valuation, see standard literature such as Franke and Hax (2003) or Perridon et al. (2009).

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Acknowledgement

Grateful acknowledgement is due to the DFG (German Research Foundation) for their support of the project “IT-Portfoliomanagement (BU 809/10-1)” making this paper possible.

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Authors and Affiliations

  1. Department of Information Systems Engineering & Financial Management FIM Research Center, University of Augsburg, Universitätsstraße 12, 86159, Augsburg, Germany

    Christian Ullrich

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  1. Christian Ullrich
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Correspondence to Christian Ullrich.

Additional information

Accepted after one revision by Prof. Dr. Buxmann.

This article is also available in German in print and via http://www.wirtschaftsinformatik.de: Ullrich, C (2013) Bewertung von IT-Investitionen mit dem Realoptionsansatz. WIRTSCHAFTSINFORMATIK. doi: 10.1007/s11576-013-0380-4.

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Ullrich, C. Valuation of IT Investments Using Real Options Theory. Bus Inf Syst Eng 5, 331–341 (2013). https://doi.org/10.1007/s12599-013-0286-0

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