Estimation of Optimum Price-Cap Level with Real Option Analysis

Abstract

This paper suggests a real-option based model to calculate optimum level of price-cap which is applied for threshold of public service pricing. Under price-cap regime, producer of utility service is not allowed to increase its price above given threshold. We assumed this relationship as a purchase of call option of given service between consumers and producers, and provided the model to calculate fair value of the option based on volatility of producers'cost.