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Real Option Exercise Decisions in Information Technology Investments: a Comment

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A Correction to this article was published on 04 November 2020

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Abstract

The paper comments on Khan et al. (J Assoc Inf Syst 18(5):372–402, 2017), who study real option exercise decisions in the context of a single IT project and in a portfolio setting, respectively. The issues identified concern the concept of (economic) rationality and the treatment of project interdependencies. The explanations provided may prove useful in other contexts.

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Change history

  • 04 November 2020

    The original version of this article unfortunately contained a mistake in the reference section, specifically references 7 and 9. Reference 7 should be changed from “Nau, Robert F, McCardle, Kevin F (1992) Arbitrage, rationality, and equilibrium, Decision making under risk and uncertainty (Durham, NC, 1990), Theory Decis. Lib. Ser. B Math. Statist. Methods, 22 pp 189–199, Kluwer Acad. Publ., Dordrecht” to “Nau RF, McCardle KF (1991) Arbitrage, rationality, and equilibrium. Theory Decis 31(2-3):199–240”. Reference 9 should be changed from “Dybvig PH, Ross SA (1987) Arbitrage. In: Eatwell J, Milgate M, Newman P (eds) The New Palgrave: a dictionary of economics, vol 1, A to D Macmillan Press, London, pp 100–106” to “Dybvig PH, Ross SA (1987) Arbitrage. In: Eatwell J, Milgate M, Newman P (eds) The New Palgrave: a dictionary of economics, vol 1, A to D. Macmillan Press, London, pp 100–106”.

Notes

  1. The setting can be generalized to multiple periods [4, 5].

  2. Preferences are assumed to exhibit monotonicity [6]. A validity of the axioms underlying expected utility is, however, not supposed.

  3. Empirical probabilities can be interpreted as unanimously held (i.e., homogeneous) probability assessments concerning the states at the end of the period [6]. Assuming homogeneous expectations does not limit the validity of my results: Where replication is possible, empirical probabilities are irrelevant (as will be shown below). Where replication fails, diverging subjective probabilities would only represent an additional source of individually differing valuations [7].

  4. See also Dybvig and Ross [9] and Sundaram [10] for treatments at a general but relatively informal level. The concept of “risk-neutral valuation” is not fully understood in prior studies cited by Khan et al. [1]. I refer to the work of Miller and Shapira [11], who state that “normative option pricing models in finance assume investors are uniformly risk neutral and consistently apply the market’s risk neutral discount rate” (p. 271). Clearly, the authors misconceive the role played by the allocative properties of financial markets.

  5. Examples within the IS literature include the papers of Benaroch and Kauffman [14] and Benaroch [15].

  6. Cochrane [25] deals with comparable problems in the intersection of macroeconomics and finance. He concludes (p. 967): “So the question ‘are those true-measure [i.e., empirical] or risk-neutral probabilities?’ is not a technicality, it is the whole question.”

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  1. University of Passau, 94030, Passau, Germany

    Josef Schosser

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The original online version of this article was revised: due to an error in references 7and 9.

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Schosser, J. Real Option Exercise Decisions in Information Technology Investments: a Comment. SN Oper. Res. Forum 1, 27 (2020). https://doi.org/10.1007/s43069-020-00032-1

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