Comparative Statics for Real Options On Oil: What Stylized Facts?
Diderik Lund & Ragnar Nymoen
Photo: The Engineering Economist
The Engineering Economist, Volume 63, Issue 1, February 2018.
An important application in the real options literature has been in investments in the oil sector. Two commonly applied “stylized facts” in such applications are tested here. One is that the correlation of the returns on oil and the stock market is positive; the other that it is invariant to changes in oil price volatility. Both are rejected in data for 1993–2008 for crude oil and Standard & Poor's 500 stock market index. Based on real options theory, consequences are pointed out. The widespread idea that higher volatility leads to increased value and postponed investment is not necessarily valid.