Question

When modeling the right to develop an oil property as a real option, and in the presence of fixed costs, using oil price volatility in the option-pricing model will

Answer 1

overestimate because the value of the option depends on the volatility of revenue

Step-by-step explanation:

The greater the market volatility, the greater the range that would be needed to determine the option premium. This would end up causing an overestimation of the premium value.

Therefore making use of oil price volatility in the option-pricing model will overestimate as value of option is dependent on how volatile the revenue is.