Impact of Probability Distributions on Real Options Valuation

This paper shows that the choice of the type of probability distribution is crucial in Real Options Analysis, because it could lead to different outcomes. This is illustrated by using the beta distribution and its special cases, such as the Program Evaluation and Review Technique (PERT) and uniform distribution to model parking garage demand uncertainty. These distributions are commonly used when there are no data available about the stochastic variable, i.e.,demand uncertainty. Beta distributions are more flexible than the PERT and uniform distribution. One of the major challenges is the practicality of the beta distribution. A good solution to this challenge is provided by the PERT distribution, because of its ease-of-use and greater flexibility than the uniform distribution. In this research, a parking garage case example is used as the base case for modeling of the parking garage demand and is refined to allow for more generic, flexible, and practical applications of the model. The impact of different probability distributions is studied on the basis of an expansion option.