I’ll give you two articles.
"Opportunity cost concept and functional analysis of financial derivatives"
Opportunity cost concept and functional analysis of financial derivatives
In the economic concepts we introduced Here, "opportunity cost" is deeply rooted in the hearts of the people. It is not only active in the economic theoretical academic community, but also deeply valued in all aspects of real economic life, and even extends to political systems, legal concepts and social management. In many aspects, such as financial investment, stocks, and securities industries, "opportunity cost" is often used together with the concept of risk, becoming the most important aspect of investment decision-making and risk judgment. Regardless of "opportunity cost", most investors will be considered "unqualified" investors.
Opportunity cost, also known as alternative cost, refers to the value of resources occupied by the production of one kind of goods that cannot be used to produce another kind of goods when production resources are limited. In other words, when a resource can only be used to produce one product, the value of the product that is not selected is the opportunity cost of the product that is selected. For example, when a batch of steel is used to produce machine tools, they cannot be used to produce cars. The value generated by producing cars is the opportunity cost of producing machine tools; similarly, when steel is used to produce cars, the value generated by producing machine tools is the opportunity cost of producing cars. Opportunity cost. Due to the limited nature of resources, producers can only make choices between different product production decisions. If they choose one, they must abandon the other. If they choose appropriately, they will have low opportunity costs and good economic benefits; on the contrary, if they choose the right ones, they will have low opportunity costs and high economic benefits. Otherwise, the economic benefits will be bad. Since opportunity cost is not the cost of actually choosing to produce a product, it is more conceptual.
Undoubtedly, this is an economic concept with great practical value. When it is introduced from the production field to the investment field, investment funds are treated as resources. When it comes to investment choices, if you choose one but not the other, you have to consider the "opportunity cost" of investment. Investors' investment decisions are all completed after comparing and selecting investment projects in many aspects. Projects that are listed in the selection but are not invested in the end naturally become the subject of opportunity cost calculation. In this subject The total value return that may be obtained from the above investment plus the investment value is the opportunity cost of the selected investment.
When the concept of opportunity cost was introduced into the investment field, people's concept of risk also underwent significant changes. In traditional investment activities, people usually only calculate costs from the investment activity itself, such as investment consulting costs, investment feasibility study costs, investment production material costs, labor costs, etc., which constitute the actual cost of investment. For an investment project or object, only the various expenditures incurred on it are within the scope of cost calculation. On this basis, the success of investment depends on the income generated after the investment, and the level of investment cost depends on the amount of income. It has nothing to do with projects outside the scope of investment activities. The investment risk under this cost concept means that there may not be any income after the investment, and the investment capital may be lost. With the concept of opportunity cost, investors have expanded the scope of risks. If the investment project or object has received benefits, it has not reached the expected level and has not reached the level of returns that may be generated by investing in another project or object. That is to say, the return level realized by the investment is not higher than the opportunity cost, which is the failure of the investment. The investment does not obtain "opportunity" returns, the investment decision is wrong, and the related investment decisions and activities are risky. .
It is this concept of investment opportunities and investment risks that has led to a revolutionary change in investors' considerations about investment. Investors no longer simply regard the direct return of investment as a factor in judging investment costs and Instead of analyzing the relationship between returns, risks and "opportunity costs", the requirements for investment success have been greatly increased.
Accordingly, people have introduced new risk analysis methods and introduced a large number of risk avoidance tools and methods, trying to obtain maximum returns or reduce risks to the minimum level in any investment activity. Financial derivatives are one of the important tools.
It should be said that what the current financial derivatives give us in the world is mainly a method and a tool. It seems to indicate that all products related to financial activities can be "derivative". Interest rates can be used, stock indexes can be used, foreign exchange can be used, and of course debt can be used. Therefore, we currently cannot subdivide the types of financial derivatives at all. Futures, options, swaps, repurchases, etc. that are generally related to financial activities are all within the scope of financial derivatives. Therefore, financial derivatives can be defined as new investment objects designed based on existing financial products. Obviously, as investment objects, the functions of financial derivatives are clear: first, the function of avoiding risks; second, the function of speculation and arbitrage. Investment has the possibility of speculation. Financial derivatives are not ordinary investment objects, and the speculative function is powerful. As far as the risk avoidance function of financial derivatives is concerned, as investors' concept of risk has expanded, this function of financial derivatives seems to be more attractive and more prominent.
Let’s discuss the stock futures index as an example. For a single investment, stock investment may be one of the riskiest investments in the world, which creates a requirement for investment hedging. Stock index futures are products "derived" in response to such requirements. For an investor with a variety of stocks, stock index futures are the most effective tool to avoid risks. They operate in the opposite direction of the stock index futures market. After a certain period of time, the price of the stock really dropped, the stock in the investor's hands depreciated, and his investment suffered a loss; however, the stock futures also fell, and he hedged by buying stock futures and won a profit in the futures market. Positive return means that the investor has no loss and may make some profit. The most common situation is that the investor loses very little.
Similarly, if an investor takes a short position after selling a stock, and the stock price rises, and shows signs of continuing to rise, this is a loss for the investor, and he needs other ways to deal with it. To compensate for this loss, he needs to buy stock futures to avoid this risk. If the stock market price rises, the loss he will suffer from selling the stock will be greater; and in the stock futures market, the stock index futures price rises, and the seller You can get a considerable amount of income by selling a contract. In this way, after the positive and negative are offset, the risk is at least reduced. The risk-avoiding function of stock index futures is particularly sufficient.
In this opposite operation between the stock market and the stock index futures market, we can pay attention to the fact that if investors are long in the stock market and do not take advantage of the futures market, With the function of hedging and preserving value, investors may have two results: first, the price of the stock rises, and investors in the stock will sell the stock and obtain considerable investment income; second, the price of the stock falls, and the investment in the stock will If the investor has to sell due to problems such as capital turnover, he will suffer a large investment loss. Compared with being long in the stock market and short selling in the stock futures market at the same time, the investor may make a lot of money, but also be short-selling in the stock futures market. It is possible to lose heavily, and the fluctuation curve of returns is sharp; but those who use the stock futures market fluctuate between no loss and no profit, and small losses and small profits, and the curve is flat.
Similarly, when investors are short-selling in the stock market, without using the stock futures market, investors may be lucky to sell in time due to the price drop, reducing losses or gaining. On the contrary, if the stock price rises, investors may regret selling stocks too early, resulting in heavy losses. Unlike using the stock futures market, the income fluctuation curve of such investment activities has high peaks and low troughs. If the stock futures market is utilized, it flattens the volatility curve of returns.
It can be seen that whether to use stock futures for reverse operations is actually a choice for investors to make insurance for their investments. If they do, investors will no longer have the huge risk of investment losses, but At the same time, it also eliminates the possibility of investors getting larger returns. You can't have your cake and eat it too, the risk is avoided, but the opportunity to make big money is also lost. We admit that this is indeed the function of financial derivatives investment to maintain value and avoid risks. However, if our understanding only stops here, our thinking will appear to be too narrow.
Careful analysis can reveal that using the stock futures market to avoid the risks of stock investment is essentially a concept that exaggerates opportunity costs. Investors invest in stocks at unrealistic levels. The cost is too high. For long investors, they exaggerate the risks caused by the possible decline in stock prices, but they do not want to sell the stocks immediately, so they use stock futures products; for short investors, they exaggerate the risks that the stock price may fall. The risk caused by the rise was exaggerated, but he had no choice but to take a short position, so he also took advantage of stock futures products. Bulls want to hold the stock, while shorts don't want to invest immediately. They consider the opposite operations as opportunity costs: bulls are afraid of greater losses if they sell the stock, while shorts are afraid that buying immediately will be extremely uneconomical. As a result, opportunity cost has become the most important consideration in investment, and at the same time it has been placed in an enlarged position, leaving investors feeling at a loss. Finally, simply use the stock futures market for "insurance". The exaggerated opportunity cost immediately becomes a realistic risk measurement. Investors use stock futures to eliminate risks and eliminate opportunities to increase returns.
However, opportunity cost is not an actual cost after all. When investing in stocks, it is necessary to consider opportunity cost. If you care too much, the meaning of investment itself will be lost. When making any investment, investment amount, actual cost expenditure, investment income and investment loss amount are four real indicators that need to be calculated. When a stock investor goes long, he should fully research and understand the situation of the stock market. , if he estimates that the stock price will fall, the simplest and most reliable response is to sell the stock in time; when a stock investor is short, if he estimates that the stock price will rise, he should buy in the stock market in a timely manner. To make profit. If the investor's estimate is wrong, the investor will need to pay the actual amount of investment loss or actual cost. Using the stock futures market to "insure" value is actually a practice of extending the existing value in hand to remain unchanged for a period of time. It no longer has anything to do with stock investors' analysis and judgment of the market. The market is rising. Yes, the value in the hands of investors remains basically unchanged. Is this an investment in a positive sense? In this regard, the value-preserving function of stock futures products is a negative tool. It deprives investors of the risk of changes in investment value and the positive power of increasing investment value.
The problem goes further than that. There are thousands of investors in the stock market. If every investor operates in this way, no matter whether he is short or long, the investment risk will be "insured" by the operation of the stock futures market. Then, the stock market will The value changes will be basically stable. From the overall situation analysis, the modern stock market, whether it is a market in a developed country or a market in a developing country, has the nature of "zero-sum transaction" or quasi-"zero-sum transaction", that is, if someone makes money in the stock market, it will definitely It's caused by other people losing money. After investors all use stock futures to protect their value, the stock market must be extremely stable. No one can take advantage of the fluctuations in the stock market to invest. In this way, the existence of the stock market will be problematic and there will be no speculation. In the stock market, what kind of speculators are there? Or ordinary investors, who doesn’t want to buy at low prices and sell at high prices? What is the need for the existence of the stock market?
From a theoretical perspective To put it bluntly, if stock futures products are only used by stock market investors as a store of value, the value store function of this product is likely to send the stock market into the museum of history.
However, actual operation shows that the stock market does not have survival problems because of the emergence of the stock futures market. On the contrary, this makes the stock market more active and more volatile. This fully tells the world that the most important function of stock futures products is not to preserve value, but to speculate. Although stock futures products are derived from stock products, they are far more speculative than the stocks themselves. This is the most important thing we have analyzed. Important conclusion.
Although there is no consistent conclusion on the functions of financial derivatives, there are different opinions on whether they are good or bad, and there is a lot of controversy. From our analysis, it can be seen that the important thing about financial derivatives is not its function of avoiding risks, but its greater speculative nature. In fact, what investors value about financial derivatives such as stock futures is their speculative function, that is, their "small and big" speculation method. There are not many people who actually use financial derivatives to avoid risks and preserve value. Such a pattern should become an important basis for studying the financial derivatives market. Of course, such a conclusion has more special significance for the policy formulation and decision-making departments of financial derivatives market management.
"New Developments in Investment Decision Theory—A Review of Research on Real Options Theory"
The current investment decision theory was produced in the mid-20th century, and its mature symbol is "Capital Budgeting" (Dean, 1951) publication of the book. Then Markowitz (1959) proposed the Portfolio Theory, and based on this, Sharpe (1964) and Lintner (1965) proposed the Capital Assets Pricing Model (CAPM). The advent of portfolio theory and CAPM bases the pricing of securities on the basis of risk and return. This is not only warmly welcomed by many investment institutions and investors, but also greatly changes the company's asset selection and investment strategy, and is widely used The company’s investment decision-making practices.
Today, the shortcomings of the current investment decision-making theory are increasingly obvious. More and more theoretical and practical workers are calling for revision of investment decision theory. Further research on investment decision theory has become the requirement of the times. In the past ten years, the development of investment decision-making theory has been mainly reflected in the research on investment decision-making theory based on real options.
1. The origin and establishment of real options theory
Real options are actual investment opportunities, which refer to rights that exist in real assets and have the nature of options. In other words, they are The concepts and methods of options are applied to real assets, especially the company's capital budget evaluation and investment decisions. Its theory originated from the dissatisfaction of practitioners, strategic experts and theoretical workers with the current investment decision-making theory.
Long before the emergence of real options theory, company managers and strategic experts intuitively recognized the value of operational management flexibility and strategic role. Therefore, in reality, they did not simply apply the net present value method. To make investment decisions, on the contrary, decisions are often made based on personal experience. Dean (1951), Hayes and Abernathy (1980), Hayes and Garvin (1982) and others pointed out that the standard discounted cash flow method often underestimates the value of investment opportunities, leading to short-sighted investment behavior and underinvestment. Decision theory workers further used the decision tree method to improve the net present value method in the 1960s. However, this can only partially reflect the flexible value of investment decisions. Myers (1977, 1987) pointed out that the traditional discounted cash flow method has its inherent flaws in evaluating investment opportunities with operating flexibility and strategic effects. He believed that the cash flow generated by investment comes from the current ownership of assets. use, plus a right to choose future investment opportunities. At the same time, he applied the concept of options to real assets and proposed that financial option pricing theory can be used to evaluate such investment opportunities.
Building on Myers's idea of ??viewing some investment opportunities as "growth options," Kester (1984) discussed the strategic and competitive role of growth opportunities. Trigeorgis and Mason (1987) pointed out that when evaluating a company's operating flexibility and strategic role, the evaluation method based on option pricing theory is a more suitable method. Baldwin and Trigeorgis (1993) pointed out that the problem of underinvestment can be solved and competitive advantage can be reestablished through proactive activities such as acquiring and managing real options of the company. Mason and Merton (1985), Trigeorgis (1988), Brealey and Myers (1991), and Kulatilaka and Marcus (1988, 1992) discussed other more general concepts of real options. Among them, Mason and Merton (1985) discussed in detail the real options of many investment operations and concentrated them on a hypothetical large-scale energy investment project.
2. Theoretical basis of real option pricing
The theoretical basis of real option pricing comes from the pioneering work on financial option pricing such as Black and Scholes (1973) and Merton (1973). . The discrete-time binomial pricing model proposed by Cox, Ross, and Rubinstein (1979) makes option pricing relatively simple and easy to implement. Margrabe (1978) discusses option pricing for swaps of two risky assets. Stulz (1982) analyzed the pricing of options on the maximum (minimum) value of two risky assets. Johnson (1987) further extended the above analysis to option pricing of various risky assets. These studies make it possible to analyze real investment opportunities (real options) that are foregone and converted. Geske (1979) discusses the pricing of compound options, which can theoretically be used to assess the value of growth investment opportunities. Carr (1988) combined the above two types of work to analyze the pricing of serial (compound) exchange options. The above work, at least in theory, can be used to price sequence investments and other actual investment opportunities (real options).
Cox and Ross (1976) pointed out that financial options can be regarded as a combination of specific tradable securities, that is, they proposed the concept of synthetic options, which makes it possible to price options. The basic feature of the risk-free pricing system is to construct a portfolio of equivalent tradable securities. Because it has nothing to do with risk attitudes and capital market equilibrium, risk-neutral pricing discounts future expected returns at the risk-free rate. Rubinstein (1976) also gave the standard Black-Scholes option pricing formula under the condition that there are no continuous trading opportunities and risk aversion. Mason and Merton (1985), Kasanen and Trigeorgis (1994) and others pointed out that in theory, real options can be priced using a theory similar to the pricing of financial options, because although real options cannot be traded, in investment decisions, we The concern is what the company's cash flows are worth if they are tradable. For real options pricing, it is sufficient to have tradable twin securities (or dynamic combinations of tradable securities) in the market that have the same risk characteristics as non-tradable real assets. Research by Garman (1976), Constantinides (1978), Harrison and Kreps (1979) and Cox, Ingersoll and Ross (1985) further shows that regardless of whether contingent equity assets are tradable or not, when pricing them, as long as we By taking the expected growth rate of a fundamental variable minus its volatility multiplied by the market price of risk, we can price it using a risk-neutral approach. This is like discounting deterministic cash flows at a risk-free rate, rather than discounting expected cash flows at a risk-adjusted discount rate.
For real assets without systematic risk, the equal certainty or risk-neutral growth rate is equal to the risk interest rate. However, if the underlying asset is not tradable, its growth rate will be lower than the equilibrium expected return on tradable financial securities of equal risk. Due to the gap between the two, dividend-like adjustments need to be made when pricing options. McDonald and Siegel (1985) pointed out that the market equilibrium model can be used to estimate the difference between the two.
3. Overview of various real option pricing theories
There are many literatures on real option pricing research. Most of these research documents analyze a certain type of real options, and generally provide analytical solutions. McDonald and Siegel (1986), Paddock, Siegel and Smith (1988) and Tourinho (1979) all discussed postponement options. Ingersoll and Ross (1992) studied the impact of interest rate changes on investment value. Pindyck (1988) studied the value of postponement options in serial investment and analyzed the optimal investment schedule. Carr (1988) and Trigeorgis (1993) also discussed the serial investment problem. Trigeorgis and Mason (1987) and Pindyck (1988) studied inflation and contraction options. McDonald and Siegel (1985) and Brennan and Schwartz (1985) analyze closure and re-operation options. Myers (1990) analyzes abandonment options. Margrabe (1978), Kensinger (1987), Kulatilaka (1988) and Kulatilaka and Trigeorgris (1994) studied conversion options. Myers (1977), Brealey and Myers (1991), Kester (1984, 1993), Trigeorgis and Mason (1987), Trigeorgis (1988), Pindyck (1988) and Chung and Charoenwong (1991) regard future investment opportunities as are growth options for the company and have been studied.
Although the above studies have enriched the theory of real option pricing, they do not have much practical application value because they mainly focus on pricing specific types of real options in specific periods of time. In reality, investment projects are generally more complex. Usually an investment includes multiple real options, and the values ??of these options affect each other. The only exception is the study by Brennan and Schwartz (1985). In the study, they analyzed the combined value of the real option of suspending (restarting) mining and the real option of abandoning mining. They pointed out that the partial irreversibility of switching mine operation status will produce an inertia or hysteresis effect, which makes It is relatively beneficial to maintain stable operating status in the long term. Although lagged utility is a form of the impact of early decisions on later decisions, they do not explicitly study the interaction between different real options.
Trigeorgis (1993) analyzed the interactive characteristics of real options and pointed out that the existence of subsequent real options can increase the value of early real options on the underlying asset, because the execution of early real options will change the underlying The value of the asset itself, thereby increasing the value of subsequent real options. Therefore, the comprehensive value of a series of real options is not equal to the simple sum of the values ??of individual real options. He also studied the main factors that determine the interaction of real options. The recent research on the correlation between real options has promoted the development of real options theory from the theoretical research stage to the practical application stage.
4. Comparative study of real options and traditional investment decisions
The traditional capital budgeting plan used by enterprises when considering investment decisions is accurate when evaluating relatively stable cash flows.
However, it ignores the management flexibility of enterprises after making decisions, and has been questioned by more and more theoretical workers and business investors in recent years. The biggest difference between real options and traditional capital budgeting evaluation methods (such as the commonly used net present value method) is that real options attach great importance to considerations in flexible decision-making.
Hayes and Gavin (1982) pointed out that the number of companies using the discounted cash flow evaluation method increased from 19 in 1959 to 94 in 1975, but it caused research and development expenses and capital investment to decrease year by year. This is because Discounted cash flow valuation methods often underestimate investment opportunities, leading to short-sighted decisions, underinvestment, and loss of competitiveness.
Donaldson and Lorsch (1983) believe that capital investment decisions using the discounted cash flow method are based on the fact that the future cash flow of the assumed investment plan is determined and the decision-maker has no opportunity to make choices or corrections after making the decision. The established policies can only be implemented passively, which makes the final results of the implementation very different from the actual business decisions of the decision-makers. In fact, the market environment is changing rapidly and is full of uncertainties such as the entry of competitors. Therefore, the real cash flow after investment may not be consistent with the pre-estimated cash flow. When the market environment and the entire operating environment change or uncertain factors disappear, The decision-maker will revise the evaluation value of the investment plan based on the new information, and the original investment decision may change as a result.
Myers (1983) pointed out that there are inherent limitations when using the discounted cash flow valuation method to evaluate operational or strategic options in investment planning. When the discounted cash flow valuation method is used to evaluate relatively stable cash flows, it is not a big problem; but when it is used to evaluate a company's growth opportunities or intangible assets, especially the value of research and development investment projects, since they are almost all option values, so Discounted cash flow valuation methods are not applicable.
Baldwin and Clark (1992) pointed out that traditional capital investment decision-making methods cannot correctly assess organizational capabilities. The development of organizational capabilities enables enterprises to more effectively exploit market opportunities and achieve better operational performance. They suggest that organizational capabilities should be viewed as a category of investment and discuss their importance in strategic capital investments. Dixit and Pindyck (1995) believe that although the net present value method is simple to use, it contains wrong assumptions, that is, investment is reversible and investment cannot be deferred. However, most investments are irreversible. ), and is deferrable.
In a volatile market environment, uncertainty and competitor reactions often cause actual earnings to differ from expectations. When new information or uncertainties become increasingly clear, companies often find that different investment projects should have different management flexibility capabilities to revise the originally set investments. For example, investments can be deferred or expanded, retrenched or even abandoned. These management flexibility that can adjust future actions according to environmental changes make the original probability distribution function of net present value asymmetric and skewed. This asymmetry and skewness comes from increasing the possible upward value and Limit possible losses on the downside. When there is a lack of management flexibility, the probability distribution of traditional net present value is symmetrical, and the expected value of net present value will conform to the expected distribution; when the effect of management flexibility is significant, it can provide adjustments for future changes or change the original setting A strategy that brings upward potential profits and limits downward losses. In this skewed and asymmetric probability distribution, its expected value will exceed the static net present value expected value. The excess is the option premium, which reflects Understand the value of management flexibility.
The proposal to use options to evaluate the capital decision-making framework is to conceptualize and quantify management flexibility. When considering the management flexibility of decision makers, it is not to abandon the traditional net present value (or discounted cash flow) method, but to quantify management flexibility through option evaluation to avoid the phenomenon of underestimation of the value of investment projects.
Basically, the greater the uncertainty about future conditions and the longer the investment period, the higher the value of the option. Traditionally, factors such as greater uncertainty and longer investment periods will reduce the net present value without real options, but will increase the value of the options (positive effect), thus offsetting the reduction in net present value without real options. The negative effect of present value increases the net present value of investment projects in the presence of real options.
In fact, the biggest difference between the option theory of capital investment and the traditional investment decision-making theory is that the former takes into account the so-called "elastic" value implicit in the investment project. Decision makers must take this elasticity into account if they are to correctly assess the true value of investment projects. The use of real options in capital investment decisions expands the information required by the discounted cash flow method of capital budgeting evaluation procedures (to account for managerial flexibility). Therefore, when faced with the evaluation of highly uncertain investment opportunities, the option evaluation method will provide more complete decision-making analysis results than the discounted cash flow method, so that it can conform to the characteristics of the investment project and make correct investment decisions.