This post is inspired by a discussion on a linkedin group I’m a member of. Other group members are suggesting that people use Black Scholes to value real options. The problem is that they do not understand the complexity of the solution they are suggesting.
Using Black Scholes on real options is the equivalent of using a chainsaw to carve the Sunday roast.
This is how they compare:
- Using them will give an output but not necessarily what you want.
- Neither is accurate.
- Both introduce risks that simpler solutions do not.
- Neither is understood by the person using them.
- Both can create real harm.
As an IT Risk Manager it is important to understand when a member of the team is using a tool that is more complex than the context allows. The two reasons the tool may be too complex are:
- Simpler solutions exist, even the team may not be aware of them.
- The tool is the best fit for the solution but the team does not understand the tool.
- The behaviour of the tool changes in different contexts that are not understood by the team.
Black Scholes for Real Options is an example of this.