- Hardcover: 320 pages
- Publisher: Wiley; 1 edition (November 8, 2002)
- Language: English
- ISBN-10: 0471263087
- ISBN-13: 978-0471263081
Review
Rarely, a book of immense breadth comes along so little understood
by its publisher that it is launched as a technical manual for industry
insiders when, in fact, it is a seminal work in many fields. Marion A.
Brach, a physician with a background in medical research and a deep
understanding of mathematics, migrated to finance. She took an interest
in real options, which is the field of valuation of choices in the real
as opposed to the financial world and in due course produced her book.
Dr.
Brach's interest is, at its core, whether X corporation should buy Y
corporation or invest a known amount of money in a project. This sort of
thing has usually been handled by discounted cash flow analysis. If Y
can add a known amount of money to X's business, then the purchase price
of Y must not exceed the discounted cash flow it brings in.
What's
wrong with discounted cash flow is that it ignores risk, as Dr. Brach
points out.That's a huge gap and one which real options can fix.
The
corrective value of real options pricing is obvious. The downside of
real options is that it takes a good deal of math, usually partial
differential equations, to do it. Financial calculators are alr eady
available at modest prices to handle the Black-Scholes model of options
pricing, but real options that involve corporate planning require a
deeper sense of what the math is about. As Dr. Brach points out, a model
for a deterministic solution, such as how much to pay for a right to
buy a what contract that will expire at a known price, zero, at a given
time, is different from the situation of a process that has a stochastic
or even randomized outcome.
Dr. Brach moves her story and
analysis from biblical accounts of grain trading and a developing and
parallel options market and Joseph's choice of whether to save grain to
guard against seven years of famine. Thales, the Greek philosopher,
bought call options on olive presses well before a harvest and was able
to raise press rents at the small cost of the options he bought.
The
story of the development of real options moves from Greek olives to
Dutch tulips and then to theories of thermodynamics. Dr. Brach mentions
the roots of real options analysis in Russian and French investigations
of probability theory, the use of Brownian motion as a foundation for
stochastic theories of where prices will be in successive periods, and
assumptions about market clearing and interest rates.
There are
investigations of the value of learning and the reduction of noise, the
applications of game theory to outcome analysis, and a consideration of
where real options is going and where its usefulness may end. The
strength of the book is its sweeping view of the field of the valuation
of events, the clarity of Dr. Brach's writing, a fine19 page
bibliography, and her ability to tell her story without delving into
mathematical physics - the source of much of the analytic power of real
options analysis.
For the investor, this value of this book about
the analysis of non-financial options is what it says about the
limitations of conventional investigations of future financial events.
For thoughtful folks not concerned about figuring out the price of a
financial options, Dr. Brach provides a glimpse of analysis as it will
likely be in a decade or two. This reviewer cannot recommend this book
too highly. For a reader with a little calculus and some statistics,
it's not hard reading. For anyone, it is an adventure with a very bright
mind-- Toronto Globe & Mail
