Valuation of Path-Dependent Contingent Claims with Multiple Exercise Decisions over Time: The Case of Take-or-Pay

Abstract

Hull and White (1993) introduced a method to extend lattice-based contingent claim valuation techniques to problems with path-dependent payoffs. This paper builds upon their method in the process of valuing two types of commodity purchase contracts that exhibit a form of timing flexibility not previously analyzed in the literature. The techniques demonstrated take advantage of characteristics of claims that simplify incorporation of path dependencies. Possible uses for the methods demonstrated include the valuation of: portfolios of mortgages, capital projects where intensity of use affects productivity of the asset, and capital projects with storage characteristics.