Modeling managerial behavior in real options valuation for project-based environments

Project valuation, as a decision-making tool for initiating investments in projects, should be able to value project flexibilities and incorporate reasonable risk preferences of relevant decision makers. Real options valuation methods are the available approaches for valuing project flexibilities, whereas they have shortcomings in considering managers’ reasonable risk preferences in project decisions. Therefore, researchers have suggested approximating the perspective on risk of real options methods and practitioners in project management. This study proposes a fair real options valuation for project-based environments by a behavioral economic approach, which adopts binomial lattice method, Monte-Carlo simulation, and cumulative prospect theory. The results show that behavioral factors such as ‘risk attitude’ and ‘loss aversion’ should be accepted in project investment decisions while limited to an acceptable amount depending on the project conditions (e.g. uniqueness of decision-making scenarios). This research contributes to the project management domain by enhancing project investment decisions that include project flexibilities.