A real options approach for valuating intertemporal interdependencies within a value-based IT portfolio management - A risk-return perspective

Value-based IT portfolio management requires the consideration of intertemporal interdependencies that may exist among IT projects. Therefore, several papers suggest adopting the real options approach in order to include intertemporal interdependencies within the valuation of IT projects. However, this paper shows that the standard Black-Scholes model, which is often used for valuating real options, is not appropriate to correctly account for project-specific private risks due to its restrictive assumptions. Since this can have major impacts on the value of IT projects, we develop an approach – based on the Black-Scholes model – to consider private risks properly within project valuation. A comparison of the results of the standard Black-Scholes model used today and our approach finally reveals that the neglect of private risks results in a systematic underestimation of both risk and return of IT projects, which may lead to wrong investment decisions.