The Sequential Compound Option Pricing with Random Interest Rate and Application to Project Valuation

Abstract

This paper proposes the pricing formula of sequential compound options (SCOs) with random interest rate and the applications call Milestone Project Valuation (MPV). Most compound options in literatures are 2-fold with constant parameters through time. The multi-fold compound options are just sequential compound CALL options. The multi-fold sequential compound options proposed in this study are compound option on (compound) option with random interest rate and allow call/put alteration. Besides, the parameters can vary in different folds and make the model more flexible. The SCOs can enhance and broaden the usages of compound option in real option and financial derivative fields, including MPV. The projects that set some critical milestones, which should be achieved sequentially, are called milestone projects. This study propose the milestone project valuation by SCOs with random interest rate.