Minimizing Hedging Error in Real Options Pricing

This paper proves a method for minimizing hedging errors when pricing real options. It proposes using a surrogate, tradable asset to hedge the non-traded project's risk. The solution involves dynamically adjusting the hedge based on the correlation between the surrogate and the project asset. Using Black-Scholes pricing logic and adapting it to real-world limitations, the model shows how firms can better control variance and manage risk when making strategic investment decisions