Rational valuation systems and compatibility of information

We introduce the concept of a rational valuation system which encompasses both the Net Present Value (NPV) methodology and martingale based methods used in connection with discrete time Real Options Analysis (ROA). This way we show that the valuation process can be looked at in separation from a specific valuation technique. We also show that flexibility and adaptability — usually presented as the main attributes of ROA — can be achieved just as well within other valuation methods via a general cost based switching scheme. We also show that the phenomenon of arbitrariness of pricing based on surrogate assets, first observed by Hubalek and Schachermayer (2001), is in fact due to incompatibility of the information structures generated by the surrogate and by the asset it replaces. Thus the use of surrogates is justifiable only if the said information structures are compatible.