Option theory and modeling under uncertainty

Christiansen, Daniel and Wallace, S W (1998) Option theory and modeling under uncertainty. Annals of Operations Research, 82 (1). pp. 59-82. ISSN 0254-5330

Abstract

Within the framework of some simple models, we explain how option theory can enhancethe understanding and teaching of modeling under uncertainty. We discuss some commonpitfalls in modeling and argue that these result from a failure to come to grips with optionsand flexibility. We examine a dynamic programming approach to evaluating options and avaluation by arbitrage approach and end by comparing the two approaches with respect tohow they treat time and risk.