Abstract
Option-pricing is used to evaluate the sequence and timing of wilderness preservation, resource extraction, and development. Resource extraction or development results in the permanent destruction of wilderness and the loss of an amenity dividend. Resource extraction does not preclude subsequent development. If the wilderness is directly developed (without prior extraction of resources), wilderness and resource extraction options are both killed. Starting from a state of wilderness, there are two stochastically evolving barriers, one for the price of the resource, and the other for the return on development. Wilderness is preserved provided the price of the resource never catches the price barrier and the return on development never catches the return barrier.
Highlights
The extension of option theory to the analysis of real investments has provided economists with new insights into the proper way to evaluate decisions which are risky and costly to reverse (Dixit and Pindyck, 1994).This approach has the potential for widespread application to problems in the field of resource and environmental economics. Brennan and Schwartz (1985) have used option theory to examine the optimal time to develop and abandon a copper mine
This paper has examined the optimal timing of preservation, resource extraction, and development of a wilderness
The fact that resource extraction or development often results in an irreversible loss of wilderness, and that the benefit and opportunity cost of such actions are uncertain, means that wilderness preservation preserves options
Summary
Wilderness is characterized by the presence of extractable resources [R(t)=I] and the absence of development [D(t)=O]. If the wilderness is developed at t='t, environmental amenities are lost forever [E(t)=O for t ~ 't]. Suppose that the value of the resources at instant t [P=P(t)) and the return on a completed development [V=V(t)] evolve according to geometric Brownian motion, with dP = IlPdt + O'pPdzp, and dV = aVdt + O'vVdzv, and where the increments dZE, dzp, and dzv are assumed to be uncorrelated. Let the cost of resource extraction be C, the cost of development with resources present [R(t)=1] be KI and the cost of development with resources absent [R(t)=O] be Ro. The option value of wilderness is identified along with the stochastically evolving barriers, P*(t) and vi (t).
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