Evaluation of an Oilfield Development Project Using Mean-Reversion Motion and Mean-Reversion with Jumps

Irreversible investments with largest outlay made with incomplete information are the mainstay of the oilfield development. Real Options Analysis (ROA) is a useful tool for making investment decisions under market uncertainty. Normal information generates continuous mean-reverting process for oil prices, whereas random abnormal information generates discrete jumps of random size. We evaluate an oilfield development project using Mean-Reversion Motion (MRM) and Mean-Reversion with Jumps (MRJ). As an example, we compare MR and MRJ valuation for the timing of investment and the optimization problem. Furthermore, we investigate the impact of varying volatility parameters of the two stochastic oil price models. This article concludes MRJ in some cases can induce better corporate decisions than MR.