Decomposition valuation of complex real options embedded in creative financial leases

Creative financial leases offer more managerial flexibility for both the lessor and lessee. The flexibility can be valued as real options, but these options are exotic and complicated, and difficult to solve using traditional approach. We propose a decomposition and diagram method and the complex real options, expressed as a portfolio of vanilla options and simple exotic options. We discuss how the approach can be applied when valuing several typical creative financial leases, including a venture lease, percentage lease, lease with deferred payment, and cancelable lease. These results can be extended to other fields of real world investment. The decomposition and diagram method can help obtain analytic solutions, which facilitate the application of the real option approach and opens up a new method of real option valuation.

► We solve complex real options with decomposition and diagram method. ► We value four typical creative financial leases. ► We obtain analytic solutions for exotic options embedded in creative leases. ► Creative financial leases offer more managerial flexibility.