Regular Paper

NASA Technology
Assessment Using Real
Options Valuation
Robert Shishko,* Donald H. Ebbeler, and George Fox

Jet Propulsion Laboratory, California Institute of Technology, 4800 Oak Grove Drive, Pasadena, CA 91109
NASA TECHNOLOGY ASSESSMENT USING REAL OPTIONS VALUATION

Received February 7, 2003; Accepted July 7, 200, after one or more revisions
DOI 10.1002/sys.10052

ABSTRACT
We examine the use of real options valuation in the context of prioritizing advanced technolo-
gies for NASA funding. Further, we offer a set of computational procedures that quantifies the
option value of each technology. Other researchers have applied a real options framework to
private sector investments. In the case of NASA investments in advanced technologies, the
underlying products, which must be used to justify the investments, are space-related
scientific results and discoveries from completed missions to be shared worldwide. As in the
private sector, uncertainty plays a significant role in the motivation to use real options in NASA.
Uncertainty in NASA technology investments can be classified as development risk and
programmatic risk (whether missions using the technology will actually fly). The latter might
be called the technology’s “market risk.” We carried out the approach on a number of planetary
exploration technologies. We illustrate the detailed calculations using one of them—light-
weight propellant tank technology. © 2003 Wiley Periodicals, Inc. Syst Eng 7: 1–12, 2004

Key words: real options; NASA technology investment; Weiner process; R&D project selection

1. INTRODUCTION

An emerging role for system engineers is to help deter-

mine the value of investing in a particular technology
that will enable some future capability. That role arises
*Author to whom all correspondence should be addressed (e-mail: because the answer is often heavily dependent on engi-
robert.shishko@jpl.nasa.gov). neering assumptions and analyses, as well as program-
matic considerations. In this paper, we seek to apply and
Contract grant sponsor: National Aeronautics and Space Administra-
extend methodologies based on options pricing theory
tion.
to address this need. In particular, we demonstrate the
Systems Engineering, Vol. 7, No. 1, 2004 use of an options pricing approach in the context of
© 2003 Wiley Periodicals, Inc. selecting those advanced technologies that should re-

1
2 SHISHKO, EBBELER, AND FOX
ceive scarce NASA funding. Further, we offer a set of
computational procedures that quantifies the option
value of each technology.
Option pricing has already been applied to a variety
of investment decisions by firms. When option pricing
applications do not involve financial instruments, the
term “real options” is used. Early applications of real
options valuation were for natural resource invest-
ments, where the underlying asset is traded in both spot
and futures markets. Later, real options calculation
methods were developed for real estate and electric
power investments, and for product development in the
pharmaceutical and entertainment industries. See, for
example, Faulkner [1996], Luehrman [1992], Majd and
Pindyck [1987], Neely [1998], and Nichols [1994].
More recently, real options modeling and analysis have
been applied to space systems in the context of on-orbit
servicing by Saleh, Lamassoure, and Hastings [2002]
and Lamassoure, Saleh, and Hastings [2002].
Advocates of real options valuation have argued that
the general ideas from options pricing theory can be
applied even when the underlying asset is not traded in
markets. They maintain that the real options valuation
captures what the project would be worth if it were
traded in a market. These arguments are articulated by
several authors in Schwartz and Trigeorgis [2001]. The
science NASA missions produce is clearly not traded in
any economic market, but market-like behavior is often
observed by those who participate in the selection of
missions.
Company research and development (R&D) funding
can be thought of as buying an option to produce new
products, without incurring the obligation to do so
unless proved economically viable. In option pricing
thinking, technology developments are treated as assets
whose payoffs are uncertain, but that have the charac-
teristic of enabling potentially spectacular returns with
limited losses.
The motivation for using real options pricing to
value technology developments in NASA is the same
as in the private sector. In the words of Robert C. Merton
in his December 1997 Nobel Lecture: “the future is
uncertain . . . and in an uncertain environment, having
the flexibility to decide what to do after some of that
uncertainty is resolved definitely has value. Option
pricing theory provides the means for assessing that
value.” [Merton, 1998: 323]
In the private sector, the ultimate products of tech-
nology investments (for example, new drugs in the
pharmaceutical industry) have the important charac-
teristic that they are private goods that go through
ordinary markets. As such, consumer demand informa-
tion, sufficient to allow future revenues to be stochasti-
cally modeled, is likely to be available. In the case of
NASA investment in advanced technologies, the ulti-
mate products, which must be used to justify the invest-
ments, are space-related scientific results and
discoveries from completed missions to be shared
worldwide. A formal options pricing approach for
NASA technology investments must consider the pub-
lic goods aspects of the ultimate products and the prob-
lem of valuing their benefits to society.1 It must also
treat the underlying uncertainties on both the invest-
ment (cost) and payoff (benefit) sides.
The calculation of a technology’s real option value
results in the amount one should be willing to pay right
now for the right to undertake the technology develop-
ment, incurring its uncertain cost and reaping its uncer-
tain benefits beginning at some time T in the future. The
monetary metric is easily understood and commensura-
ble across other technology investments. Moreover, the
timing of both costs and benefits is treated explicitly,
unlike some other approaches to R&D project selection.
It is not our intention in this paper to provide a tutorial
on real options pricing theory; some familiarity with the
basic concepts, in fact, has been assumed. There are a
number of books on real options theory that the reader
may consult to understand the underlying concepts and
to gain an appreciation for the difference between real
options valuation and such time-honored approaches as
Net Present Value (NPV) analysis. These books include
Trigeorgis [1996] and Schwartz and Trigeorgis [2001].
2. ADVANCED TECHNOLOGY
INVESTMENTS IN NASA
2.1. Technology Readiness Levels
At NASA, technologies are categorized by their matur-
ity, which is defined by a qualitative measure called the
Technology Readiness Level (TRL). The nine-point
TRL scale is described in Table I. In this paper, we will
concentrate on developing the real options approach for
those long-range, higher-risk technology investments.
These investments generally are designed to move a
technology with a TRL < 6 up to a TRL = 6, at which
point a funded NASA mission can assume responsibil-
ity for its full development. Using the formal three-
tiered structure proposed by Hauser [1998], these
1
A pure “public good” has the characteristic that one person’s
consumption of these products does not diminish another’s. As a
consequence of nonexcludability and other factors, the analysis of
public goods markets differs from that of strictly private goods. While
the focus is on NASA’s problem, the approach presented should be
applicable with some modifications to investment in advanced tech-
nologies that support the creation of any public good. In particular,
the Department of Defense (DoD) faces a similar problem. In that
case, the public good is “defense,” rather than space-related science
products.
 NASA TECHNOLOGY ASSESSMENT USING REAL OPTIONS VALUATION
TABLE I. NASA Technology Readiness Level Definitions
investments fall into Tier 1 (Basic Research Explora-
tions) and Tier 2 (Development Programs to Create
Core Technological Competence). “Productizing” a
specific technology falls into Tier 3 (Applied Engineer-
ing Projects), and is accomplished during the develop-
ment phase of a funded NASA mission that uses the
technology.
2.2. Types of Uncertainty
Uncertainty in NASA technology investments can be
classified as development risk (cost, schedule, and tech-
nical performance) and programmatic risk (whether
missions using the technology will actually fly). The
latter might be called the technology’s “market risk.”
A technology’s option value must ultimately depend
on its market success as well as its development
success. To be credible, any real options valuation
equation must reflect these types of uncertainty and
capture them quantitatively. A brief description of
these uncertainties in a typical NASA technology
investment is warranted.
Development risk is more easily understood. Each
early (low TRL) NASA technology investment faces
uncertainty about the cost of bringing it to TRL = 6 by
a particular date, even if its development team is com-
pletely successful. There may be several reasonable
paths to achieving TRL = 6, each with its own pace,
resource requirements, and risks. Generally, by increas-
ing the amount of resources, the date can sometimes be
moved forward and the probability of a successful
development increased. Indeed, one can picture a sur-
face representing (at each point in time) the feasible
combinations of the probability of development suc-
cess, development time, and expected development
cost. A technology’s real option valuation must explic-
itly depend on the technology’s delivery date, and take
3
into account the cost probability density and probability
of meeting its technical performance.
Programmatic risk arises because how many mis-
sions and which missions NASA will choose to fly in
the future is not known with certainty. Mission “road-
maps” exist, along with strategic plans directed at par-
ticular space science and exploration goals. Missions
(conceptual versions, at least) in the current roadmaps
have a higher probability of being flown than missions
not currently on such roadmaps. However, missions on
the roadmap could conceivably be replaced by new
missions, not currently planned; and new missions
could be added to the roadmap in future years. One
reason for this uncertainty is that future NASA budgets
and their allocation are not fully predictable.
Whether any particular future mission flies is linked
to its perceived value (as measured by society’s will-
ingness-to-pay) at some future date. That value could
be substantially greater than we now perceive or it
could be much less, because serendipitous science
discoveries from earlier (flown) missions could alter
NASA’s selection of future missions altogether.2
Moreover, the further out one looks, the uncertainty
increases about a mission’s value and its science and
technology content.
2.3. Role of Real Options
The real options framework confers some true advan-
tages for NASA in its strategic planning (over other
methods for selecting technology investments such as
net present value). The real options framework values
2
One example might be the discovery of subterranean life on
Mars, following which additional expeditions (both crewed and
robotic) are sent to Mars at the expense of other space science
missions.
4 SHISHKO, EBBELER, AND FOX
technology investments by taking into account the
flexibility they can offer in the face of considerable
uncertainty. NASA, as the holder of these real options,
can decide to invest in missions, wait, abandon, or
change missions in response to better information as
some of these uncertainties are resolved. In simplest
terms, the real options framework captures the addi-
tional value inherent in some technologies that cur-
rently goes unrecognized in the NASA budgeting
process. Using the real options framework, NASA can
achieve greater strategic flexibility with its limited tech-
nology budget.
3. THE REAL OPTIONS EQUATION
The value v of a real (non-income producing) option
that pays off W(T) at time T is given by the general
formula:
v(t, T ) = exp(−r(T − t))E[max(0, W(T ))],
where t is current time, E denotes the expected value in
a risk-neutral world, and r is the riskless discount rate.
A full explanation of Eq. (1) is beyond the scope of this
paper. However, the basic idea was very concisely ex-
plained by the following paragraph in Schwartz and
Trigeorgis [2001: 452–453]:
Consider, for example, an R&D investment or pilot
project to the testing and development of an alternative,
lower-cost technological process. Such a strategic in-
vestment opportunity can be viewed as a call option,
having as [its] underlying asset the present value of the
expected cash inflows from the completed and operat-
ing follow-on project, VT, with [the] exercise price
being the necessary investment outlay, I. The ability to
defer investment in the follow-on project under market
demand uncertainty creates valuable flexibility for
management. If, during the later stages, market de-
mand develops favorably, the firm can make the fol-
low-on investment and obtain the project’s net present
value at that time, NPVT = VT – I [≡ WT]. If, however,
market demand is weak, management can decide not
to invest and its value would be truncated to 0.
The discount factor, exp(r(T – t)) in Eq. (1), which is
just a constant, brings the monetary value back to
current time t.
The risk-neutral environment allows the use of the
riskless discount rate (i.e., the risk-free interest rate such
as that on a government-backed security), which obvi-
ates the need to make assumptions about risk aversion
and risk premia in valuing risky projects. In options
pricing theory, the existence of a traded “twin security,”
which has the same risk characteristics as the project, is
sufficient to justify risk-neutral valuation. One unre-
solved issue here concerns whether NASA (as a gov-
ernment agency) should be risk-neutral altogether
without regard to whether uncertainties can be hedged
(with a traded twin security) or not. We have implicitly
argued that the public goods aspect of NASA invest-
ments suggests that NASA should be risk-neutral in
valuing its R&D projects, thus validating the use of a
riskless discount rate.
The application of Eq. (2) to NASA technology
evaluation was elaborated in a paper by one of us
[Shishko, 1997], in which we needed to explicitly treat
the technology’s development cost and probability of
success. The development cost was treated as a re-
quired payout whose amount was uncertain. The ex-
pected development cost was calculated over all
(proposed) paths leading to TRL = 6, and then dis-
counted appropriately. Thus, the first risk-neutral ex-
pectation, E[ ], in Eq. (2) is taken over technology
(1) development outcomes, while the second is taken
over “states of the world” in which different mission
sets are realized.
From basic principles, one can derive the real op-
tions valuation equation applicable to NASA technol-
ogy evaluation. This is documented in Shishko and
Ebbeler [1999].
 T 
vi(t, T ) = max 0, −E ∑ ci (τ) exp(−r(τ − t))

  τ=t 
  
∗
   T  
     (2)
 + pi,T E ∑ max  ∑ i,k
0, X (τ) exp(−r(τ − t))  ,
 k  τ=T  
    
where
Xi,k(τ) = V MPi,k(τ) − MCi,k(τ)
and
vi(t, T) = the option value of technology i at time t
for a technology readiness date of T,
r = the riskless discount rate,
ci(τ) = the development cost of technology i in period
τ for a technology readiness date of T,
pi,T = the probability that the technology i develop-
ment program will be successful by the technology
readiness date T,
Xi,k(τ) = the net marginal value of the technology i
in project/mission k in period τ, given a successful
technology i development program,
VMPi,k(τ) = the value of the marginal contribution of
technology i in project/mission k in period τ, given a
successful technology i development program,
 NASA TECHNOLOGY ASSESSMENT USING REAL OPTIONS VALUATION
MCi,k(τ) = the marginal cost of “productizing” tech-
nology i in project/mission k in period τ, given a suc-
cessful technology i development program,
T* = the time horizon (T* ≥ T ≥ t).
The form of the equation is tied to the earlier discus-
sion about the tradeoff surface among T, pi,T, the ex-
pected cost of reaching TRL = 6, and the achieved level
of technical performance following development. We
essentially chose to hold T and the achieved level of
technical performance constant, while allowing the
probability of development success and cost to vary
concomitantly. Another approach would be to hold T
constant, set the probability of development success
equal to 1, while allowing the achieved level of techni-
cal performance and cost to vary concomitantly.
Whether the achieved level of technical performance is
treated stochastically or not, Xi,k is conditional on its
state at time T.
Monte Carlo simulation is the natural tool for ap-
proximating the expected values in Eq. (2). A generic
procedure for computing a technology’s real option
value using Monte Carlo simulation involves the fol-
lowing steps:
1. Simulate sample paths for the underlying mission
value.
Figure 1. Simplified flow chart for NASA technology real options valuation.
5
2. Compute the technology’s payoff for each sam-
ple path.
3. Discount and average the simulated payoffs to
obtain the option value using Eq. (2).
By increasing the number of simulated sample paths,
an arbitrary degree of accuracy can be obtained. Today,
the computational intensity of Monte Carlo simulation
tends to be driven by the complexity of the behavioral
models using the stochastic variables. For NASA tech-
nology investments, the behavioral models for the un-
derlying asset (i.e., mission) value are likely to be much
less complex than in the financial world for the foresee-
able future. Computational time is, therefore, unlikely
to be a problem.
However, we do not wish to minimize the effort
needed to build a credible behavioral model or simula-
tion for each technology investment. For many ad-
vanced space technologies (in our experience), the
payoff is highly dependent on the number of missions
that “fly” the technology, i.e., the flight rate. This flight
rate is often highly uncertain and poses a modeling and
simulation challenge. In keeping with a commonly used
technique in real options valuation, we modeled the
flight rate as a diffusion process (geometric Brownian
motion). The specific procedure used in our demonstra-
tion application below is depicted in Figure 1.
6 SHISHKO, EBBELER, AND FOX
4. APPLICATION TO A TECHNOLOGY
For this paper, we selected ultralight propellant tank
(UPT) technology to demonstrate the application of the
real options approach. UPT technology can be applied
in a variety of mission classes. We grouped these into
those in which g-forces are high and those in which they
are low. Table II shows some mission classes within
these two groups, and for each mission class, the best
currently feasible tank technology that would be used
should the UPT technology development fail.
4.1. Flight Rates
The real options equation requires that alternative fu-
ture demand scenarios for UPT technology be simu-
lated under stochastic assumptions. This demand for
UPT technology depends heavily on the flight rates for
each mission class. Within each mission class, NASA
flight rates are very uncertain over a 15- to 20-year time
horizon. Further, the timing of launches to planetary
bodies is dictated by orbital mechanics if near-mini-
mum energy trajectories are desired. This results in
certain “blackout periods” for some planetary mission
classes during which any projection of the flight rate
should be constrained to zero.
We generate stochastic flight rates for each simula-
tion trial using an integrated lognormal Weiner process
with parameters chosen for each mission class and with
constraints on launch opportunities and technology
readiness. The algorithm starts with an initial launch
rate (e.g., one launch every 4 years) that is modified
with a lognormal Wiener process to simulate changes
through time. We call the mean of this Weiner process
the drift rate of the flight rate (in percent/year) and the
standard deviation of the Wiener process is the volatility
of the flight rate (in percent/year1/2). The instantaneous
flight rate P is always nonnegative. We integrate the
instantaneous flight rate through time to obtain Q,
starting from an initial progress value Q(0) to get the
TABLE II. Mission Classes for Ultralight Propellant Tank Application of Real Options
Valuation
percent of progress in getting to the next launch date.
Whenever this progress metric gets to 1, a launch oc-
curs, unless the mission is in a blackout period, in which
case the launch is delayed until the next opportunity. If
the technology is not ready by the launch date the
technology gets no credit, as it wasn’t available to
support the mission. We calibrate the model for known
mission launches by adjusting the initial flight rate and
the initial progress metric to match currently proposed
flight schedules. In equation form, the algorithm is
Q(t) = ∫ P dτ + Q(0),
dP = αP dt + σP dz. (3)
where α is the drift parameter, σ is the volatility parame-
ter, and dz is a normal random variable with zero mean
and variance dt. These values are laid out in Table III
for our “nominal case.” Note that the negative initial
value for the Mars Sample Return integrated flight rate
provides a way of more or less ensuring that its launch
will not occur before some years in the future.
4.2. Mass Benefits
The next part of option value calculation is to deter-
mine, for each mission class, how much mass is saved
by UPT technology and how many dollars that repre-
sents. The amount of mass savings depends primarily
on the spacecraft dry mass, but also on the mission class,
mission destination, and the current tank technology the
UPT technology is replacing. For planetary missions
with a spacecraft dry mass between 500 and 1000 kg as
an example, the UPT technology mass savings were
determined from a detailed engineering analysis of a
Europa Orbiter mission. That analysis resulted in the
proximate relationship, shown as Eq. (4), we used in
calculating the mass savings for other planetary mis-
sions:
 NASA TECHNOLOGY ASSESSMENT USING REAL OPTIONS VALUATION 7

TABLE III. Flight Rate Simulation Parameters by Mission Class (Nominal Case)

(∆v)k (4) We also examined a much larger number of conceptual

∆Mi,k ≅ 0.02ai M dry
sc .
(∆v)0
In Eq. (4), ai adjusts the results for what was consid-
ered the next best available tank technology, i,
(∆v)k/(∆v)0 is the delta v required for mission desti-
nation k relative to the delta v for a mission to Europa,
and M dry
sc is the spacecraft dry mass. The mass savings
depend on the dry mass of the spacecraft to be launched,
but the spacecraft dry mass for each launch within a
mission class is itself uncertain. We determined a prob-
ability distribution for spacecraft dry mass for each
mission class, and translated that into mass savings
attributable to UPT technology for each launch gener-
ated by the flight rate algorithm.
To translate the mass savings into dollars required a
value known as a “shadow price,” in this case the
shadow price of mass for each mission class. The
shadow price is typically the marginal cost or “oppor-
tunity cost” of some resource. For each mission class,
we examined previous missions in that class for which
the actual marginal cost of mass could be determined.
missions for which the marginal cost of mass could only
be imputed. Since the data showed a range of values for
the shadow price even within a mission class, we placed
a probability distribution on it. In most cases, a simple
triangular distribution was applied, but, for the Europa
Orbiter class, a uniform distribution was selected.
4.3. Simulation Results
We used a homegrown Monte Carlo simulation tool
coupled to a commonly used spreadsheet to run all our
trials, though any commercial Monte Carlo simulator
could have been used. For each mission class, the Monte
Carlo analysis generated a graph like the ones in Figures
2–4, which is for the Earth-orbiting class. The figure
shows the dollar savings for the nominal case and the
lightest titanium (Ti) tank. The expected savings were
about $100M, which is the numeric value that goes into
the second expected value term in the real options
equation. Of course, the results for the other mission
classes are to be included as well, and naturally, because
of their much lower flight rates, contribute less to the

Figure 2. Simulation results for the Earth Orbiter Mission Class (nominal case, lightest titanium tank).
8 SHISHKO, EBBELER, AND FOX
Figure 3. Simulation results for the Earth Orbiter Mission Class (+1% flight rate drift, +10% volatility case, lightest titanium
tank).
overall savings. However, the Mars Sample Return
mission class, shown in Figures 5–7, contributes sig-
nificantly because of the high value of the mass savings.
The reader should recognize that in the nominal case,
where the volatility is zero, the Monte Carlo simulation
still results in a distribution because of the stochastic
nature of the mass savings and the mass shadow price.
When volatility in the instantaneous flight rate is intro-
duced (Figs. 6 and 7), the resultant benefits pdf is
multimodal . We believe this is a consequence of several
factors: the higher probability of both earlier launches
and later launches, the blackout period for Mars
launches, and the discounting of the benefits occurring
in different years.
4.4. Development Cost and Probability of
Success
The expected development cost of a UPT technology is
the first expected value term in the real options equa-
tion. Because of the fairly advanced TRL of the titanium
Figure 4. Simulation results for the Earth Orbiter Mission Class (–1% flight rate drift, +10% volatility case, lightest titanium
tank).
(Ti) and aluminum (Al) UPT technologies, the remain-
ing developments costs to TRL = 6 ranged from just
over $1M to just under $2M. We constructed a decision
tree using the nominal development schedule and
budget extracted from the technology development plan
supplied by the cognizant technology manager. Prob-
ability elicitation of the manager or system engineer
was used to estimate the risk of failure at each milestone
or critical test, and the recovery activities and costs were
included at each failure branch of the tree. Thus, the
decision tree when completed also provided the overall
probability of development success needed in the real
options equation.
The development of the decision tree here is strongly
related to traditional systems engineering risk manage-
ment: Much of the same information is needed to per-
form an integrated cost and schedule risk assessment
for the technology development project. If the amount
of cost and schedule risk information available is rela-
tively rich (evidenced by a detailed project WBS and
 NASA TECHNOLOGY ASSESSMENT USING REAL OPTIONS VALUATION 9

Figure 5. Simulation results for the Mars Sample Return Mission Class (nominal case, best titanium tank w/diaphragm).

Figure 6. Simulation results for the Mars Sample Return Mission Class (+1% flight rate drift, +10% volatility case, best titanium
tank w/diaphragm).

Figure 7. Simulation results for the Mars Sample Return Mission Class (–1% flight rate drift, +10% volatility case, best titanium
tank w/diaphragm).
10 SHISHKO, EBBELER, AND FOX

TABLE IV. Simulation Results for Hi-g Applications: Benefits of Mass Savings by Mission Class in $M (mean,
[standard deviation]) Based on 20,000 Trials

TABLE V. Simulation Results for Low-g Applications: Benefits of Mass Savings by Mission Class in
$M (mean, [standard deviation]) Based on 20,000 Trials
 NASA TECHNOLOGY ASSESSMENT USING REAL OPTIONS VALUATION
TABLE VI. Sensitivity of Real Options Value
(Aluminum Ultralight Tanks) to Drift and Volatility
Parameters
network schedule), then the analyst should run a sepa-
rate Monte Carlo simulation. More typical is the situ-
ation where such information is sparse. In those cases,
we have used a simple decision tree to capture technol-
ogy development cost and success uncertainty.
Table IV shows the means and standard deviations
for the simulation results for the hi-g applications for
two UPT technologies (Ti and Al). The elicited decision
trees for these technology developments contained
three outcomes representing three different degrees of
technology development success; each of these natu-
rally implied a different mass savings benefit since UPT
mass would be different. Each outcome’s probability of
occurrence is also shown in the table. The best currently
feasible tank technology alternative for high-g missions
is a 40-mil Ti tank like the one flown on the Mars
Pathfinder mission. The mean benefits and standard
deviations reported in Tables IV and V are based on the
mass savings relative to the 40-mil Ti tank. Table V
shows the means and standard deviations for the simu-
lation results for the low-g applications for the Ti UPT
technology, along with the best currently feasible low-g
tank alternatives—a 16-mil tank, proposed by the Outer
Planets Program for the Europa Orbiter mission, and a
5-mil Earth orbiter UPT technology. For each case, the
probability of technology development success (from
Tables IV and V) is multiplied by any expected positive
mass savings benefits ( = UPT technology benefits
TABLE VII. Sensitivity of Real Options Value
(Titanium Ultralight Tanks) to Drift and Volatility
Parameters
11
minus the benefits of its best currently feasible alterna-
tive technology) to get the unconditional net benefits
for that case. Aggregation over all cases and netting out
the (fairly negligible) expected development costs
yields the real option value calculated in Eq. (2). All
future dollar denominated benefits and costs were dis-
counted at a riskless rate, taken here to be 4.5%.
4.5. Sensitivity Analysis
It is instructive to see how the real option value changes
from the nominal case as the drift and volatility parame-
ters were varied. Tables VI and VII show that for the Al
UPT and Ti UPT, respectively. Note that a positive drift
indicates a rising trend in the instantaneous flight rate
over the 15-year time horizon in the analysis.
5. CONCLUSIONS
Real options valuation is a comparatively new tech-
nique, now recognized in modern business schools, as
a way of valuing projects in an environment of extreme
uncertainty. It is, in fact, tailor-made for evaluating
advanced technology development efforts, even in non-
market situations. We believe that our real options
framework can be used to value investments in other
advanced space technologies within the human explo-
ration3 and commercial space sectors. However, to ap-
ply the real options approach to advanced technologies
still requires good systems thinking and engineering
analyses to build a credible simulation of the alternative
sample paths for a particular technology development.
ACKNOWLEDGMENTS
The research described in this paper was carried out at
the Jet Propulsion Laboratory, California Institute of
Technology, under a contract with the National Aero-
nautics and Space Administration.
REFERENCES
T.W. Faulkner, Applying “options thinking” to R&D valu-
ation, Res Technol Management 39(3) (May–June 1996),
50–56.
J.R. Hauser, Research, development, and engineering met-
rics, Management Sci 4(12) (December 1998), 1670–
1689.
3
For example, product improvement technologies for extending
the service life of the International Space Station (ISS). The disposal
date of the ISS would have to be included as an endogenous stochastic
variable in any simulation to calculate those real option values.
12 SHISHKO, EBBELER, AND FOX

E. Lamassoure, J.H. Saleh, and D.E. Hastings, Space systems
flexibility provided by on-orbit servicing: Part 2, J Space-
craft Rockets 39(4) (July–August 2002), 561–570.
T.A. Luehrman, Arundel partners: The sequel project, Har-
vard Business School Case #9-292-140, Cambridge, MA,
1992.
S. Majd and R.S. Pindyck, Time to build, option value, and
financial decisions, J Fin Econ 18(1) (March 1987), 7–28.
R.C. Merton, Applications of option-pricing theory: Twenty-
five years later, Amer Econ Rev 88(3) (June 1998), 323–
349.
J.E. Neely III, Improving the valuation of R&D: A composite
framework of real options, decision analysis and benefit
valuation frameworks, Ph.D. thesis, MIT International
Center for the Management of Technology, Cambridge,
MA, June 1998.
N.A. Nichols, Scientific management at Merck: An interview
with CFO Judy Lewent, Harvard Bus Rev 72(1) (January–
February 1994), 89–99.
J.H. Saleh, E. Lamassoure, and D.E. Hastings, Space systems
flexibility provided by on-orbit servicing: Part 1, J Space-
craft Rockets, 39(4) (July–August 2002), 551–560.
R. Shishko, Strategic technology portfolio selection: Devel-
oping a systematic approach, unpublished JPL proposal,
Jet Propulsion Laboratory, Pasadena, CA, September
1997.
R. Shishko and D.H. Ebbeler, Strategic technology portfolio
selection: An options pricing approach for NASA, JPL
900-990, JPL Economic Research Series, Jet Propulsion
Laboratory, Pasadena, CA, May 1999.
E.S. Schwartz and L. Trigeorgis (Editors), Real options and
investment under uncertainty: Classical readings and re-
cent contributions, MIT Press, Cambridge, MA, 2001.
L. Trigeorgis, Real options: Managerial flexibility and strat-
egy in resource allocation, MIT Press, Cambridge, MA,
1996.

Robert Shishko is currently a Principal System Engineer and Economist in the Mission and System
Architecture Section of the Jet Propulsion Laboratory (JPL), California Institute of Technology. Dr.
Shishko received two S.B. degrees from MIT (1968), and his M.Phil. (1970) and Ph.D. (1972) in
economics from Yale University. He has been at JPL since 1983, and is currently working to improve the
practice of systems analysis and engineering at JPL and across NASA. He has worked on the International
Space Station and Mars Pathfinder mission, and was one of the “founding fathers” of JPL’s Project Design
Center. Dr. Shishko served as task manager and principal contributor to the NASA Systems Engineering
Handbook, for which he received the NASA Exceptional Achievement Medal in 1996. Prior to coming
to JPL, Dr. Shishko worked at the Rand Corporation (1970–1983) on a variety of defense resource
allocation and management issues. He has been an adjunct Associate Professor of Economics at the
University of Southern California. He has served on the part-time faculty of the International Space
University (Strasbourg, France) and is a visiting lecturer in systems engineering at MIT.

Donald H. Ebbeler is on the technical staff at JPL. He has been involved in the modeling and analysis of
both the engineering reliability and economic aspects of solar energy, war-gaming, cost prediction,
aerospace propulsion, electro-optical, structural, mechanical, chemical, advanced automobile air bag
systems, and optical space interferometer system designs. Before coming to JPL in 1980, he worked as
an aerospace research engineer for General Motors, served as an assistant and associate professor of
economics at Georgia Institute of Technology, Claremont Graduate School and the University of Iowa,
and as an economist at Southern California Edison. He has been on the editorial board of the Journal of
Macroeconomics since its founding in 1979. He graduated from Purdue University in 1970 with an M.S.
and Ph.D. in Economics. In 1964 he earned a B.S. in Electrical Engineering in the R&D option, with
concentrations in physics and mathematics, and in 1965 earned an M.S. in Electrical Engineering,
specializing in statistical communication theory with a concentration in statistics, both from Purdue
University.

George Fox: Engineers used slide rules when George entered Caltech as a freshman in 1965. A Caltech
Ph.D. in Applied Physics and Economics followed in 1979. George joined JPL in 1980 to study the
economic value of solar energy to utilities. Then followed work on military acquisition policy analysis,
war game modeling, and simulation. An original codeveloper of the Space Station Freedom System Design
Tradeoff Model, he also pioneered new systems models and analysis for projects in JPL’s Project Design
Center and new planning and scheduling tools used by NASA’s Deep Space Network. He currently does
reliability modeling of complex systems and dynamic cost risk and technology valuation using real options
models to value portfolios of NASA technology developments and the space mission projects that use the
resulting products.