Real option valuation in private equity: interest rate dynamics, binomial lattice modeling, and integrative perspectives

Abstract

This dissertation explores private equity (PE) valuation under uncertainty through the lens of real option theory and interest rate sensitivity, addressing the limitations of traditional valuation models. This research is structured in three studies: (1) a bibliometric and theoretical review mapping real option valuation in private equity, (2) an empirical study of the effects of interest rate dynamics on real option valuation of PE deals using the Black and Scholes model, and (3) the application of the binomial lattice model (Cox-Ross-Rubinstein) to capture staged investment and flexibility in PE transactions across 454 peer-reviewed studies and eight private equity transactions (Qualtrics International Inc, Toshiba Tec Corp, Univer Solutions LLC, Coupa Software Inc, Dell Technologies Inc, Refinitiv (London Stock Exchange Group PLC), McAfee Corp., and Squarespace Inc., where this research shows call values are highly sensitive to interest rate fluctuation whereas put values provide a consistent downside protection. The binomial lattice model provides a more realistic valuation under volatility, overall suggesting real option models provide a robust alternative to traditional valuation models, especially in volatile environments and macroeconomic shocks, providing more accuracy in the decision-making process for investment analysts, fund managers, consultants, regulators and academic researchers.