Offshore Outsourcing Contracts : Real Options Analysis Using Trinomial Option Pricing Model

In this paper, we analyze offshore outsourcing contracts using the trinomial model, which is very useful in analyzing real options associated with offshoring projects. Earlier studies by Grenadier (1995) and Pashley, Krishnaswamy and Gilbert (1997) used the option pricing model to analyze lease contracts and debt contracts respectively. So far, however, no studies address offshore outsourcing contracts. Gopal, Mukhopadhyay, Krishnan, and Sivaramakrishnan (2003), Ethiraj, Kale, Krishnan, and Singh, (2004), Gopal and Koka (2010), and Gopal and Koka (2012) found through empirical studies a significant relationship between profits and type of contracts, and price and types of contracts respectively. But they do not provide a theoretical basis for their findings. In this paper we provide a theoretical basis for such a relationship employing the real options analysis using trinomial option pricing model.