The Tourinho model: neglected nugget or a receding relic?

Research output: Contribution to journalArticle

Abstract

This article evaluates Tourinho's (1979b) work as one of the earliest contributors to the real options literature. His model pioneered the application of risk neutrality to uncertain investments, but his originality of introducing an option-holding cost albeit to overcome the extraction paradox is rarely imitated. We claim that the combination of a convenience yield and an option-holding cost produces a more satisfying representation. Moreover, variations in the holding cost give rise to a host of investment decisions ranging from the standard real option solution for a zero-holding cost to a net present value solution for an infinite-holding cost. Not only does the holding cost mediate between these two poles, but it provides the option seller (usually a landowner or a government) with a policy instrument for influencing the extraction timing and thus the extraction profit of the option buyer. We derive the holding cost that optimizes the landowner's combined value of the option premium, holding costs and eventual royalties. © 2013 Copyright Taylor and Francis Group, LLC.

Bibliographical metadata

Original languageEnglish
Pages (from-to)604-624
Number of pages20
JournalEuropean Journal of Finance
Volume19
Issue number7-8
DOIs
Publication statusPublished - Sep 2013