Quasi-option Value Research Articles

The Uncertainty Problem in Cost-Benefit Analysis Expanded: A Current Review

This article examines the current state of cost-benefit analysis and its limitations. The review was completed by looking at current literature of cost-benefit analysis with the most up to date developments. Currently, it faces known challenges in quantifying subjective human elements, incommensurable costs and benefits, difficulty in measuring and discounting future benefits and costs, and the potential lack of impartiality in regulatory settings. However, this article uniquely addresses a paradox in the analysis process itself related to the discovery of new information. Methods to mitigate risk and uncertainty, such as sensitivity analysis, Monte Carlo simulations, and scenario analysis, are analyzed. Additionally, quasi-option value is addressed as it relates the discovery of new information. Despite these approaches to mitigate uncertainty, uncertainty remains a fundamental challenge in achieving true optimality through cost-benefit analysis. However, it is found that despite the paradox identified in this article, it can still be a useful tool in evaluating decision alternatives.

WEATHER AT DIFFERENT GROWTH STAGES, MULTIPLE PRACTICES AND RISK EXPOSURES: PANEL DATA EVIDENCE FROM ETHIOPIA

This study investigates the effects of combinations of climate smart agricultural practices on risk exposure and cost of risk. We do this by examining the different risk components — mean, variance, skewness, and kurtosis — in a multinomial treatment effects framework by controlling weather variables for key stages of crop growth. We found that adoption of combinations of practices is widely viewed as a risk-reducing insurance strategy that can increase farmers’ resilience to production risk. The hypothesis of equality of weather parameters across crop development stages is also rejected. The heterogeneous effects of weather across crop growth stages have important implications for climate change adaptation to maximize quasi-option value. For a country that has the vision to build a climate-resilient economy, this knowledge is valuable to identify a combination of climate smart practices that minimizes production risk under variable weather conditions.

Uncertainty, learning, and local opposition to hydraulic fracturing

New extraction technologies, including hydraulic fracturing (fracking), have increased fossil fuel reserves in the United States. Despite local economic benefits, many jurisdictions have adopted bans on fracking. We develop a dynamic learning model parameterized with a computable general equilibrium (CGE) model to quantify the associated quasi-option value (QOV), and to explore if uncertainty about environmental damages with the potential to learn can rationalize such bans. The model is calibrated to a representative municipality in Colorado, the site of several fracking bans. With plausible damages, we find that the QOV increases the incentive to delay drilling within a range of energy prices. The results suggest that improving the ability to learn about fracking impacts could increase the prevalence of bans in the short run and lead to better policymaking over time. Incorporating CGE output into a dynamic learning framework permits calculation of the locality-wide QOV associated with a range of policies.

The key literature of, and trends in, forestry investment decisions using real options analysis

SUMMARY This paper presents trends and development of real options analysis (ROA) in the field of forestry investment decision making. A literature review was conducted similar to Newman's (2002), which presented the Faustmann framework of optimal forest rotation literature in forestry investment decisions. Eighteen forestry and non-forestry journals, along with significant books on ROA, are reviewed. Although real options applications in the field of forestry are relatively new, as compared to Faustmann's discounted cash flow technique, numerous journals contain articles on ROA in forest investment decisions. The application of real options in forestry investment decisions developed during the late 1980s from the simple topic of nature preservation employing a quasi-option value. This analysis method has recently been applied to much larger problems of timber cutting contracts employing Monte Carlo simulation approaches. In addition, geometric Brownian motion and mean reversion, two of the most prevalent...

Determining public attitudes and willingness-to-pay for artificial lakes protection

Abstract This study explores factors influencing people's willingness to pay (WTP) for protecting an artificial lake. WTP was derived from a face-to-face survey of 564 recreational users of Plastira Lake, one of the most important constructed wetlands in Greece. Key elements in this research were the uses of adequate econometric models to tackle protest answers and of a scale for measuring the dimensions of Total Economic Value of a water resource. The results indicated relative importance of particular value components in determining water resources conservation preferences and individuals’ willingness for protecting them. We extract four factors (water use, production, flora and fauna and quasi-option values) and explore their influence on respondents’ WTP. Various demographic variables together with the extracted factors show a strong impact on WTP and the specific amounts stated. The study contributes to understanding of values underlying conservation decisions and help policy makers promoting strategies for protecting water resources.

Acknowledgement of reviewers

This study explores factors influencing people's willingness to pay (WTP) for protecting an artificial lake. WTP was derived from a face-to-face survey of 564 recreational users of Plastira Lake, one of the most important constructed wetlands in Greece. Key elements in this research were the uses of adequate econometric models to tackle protest answers and of a scale for measuring the dimensions of Total Economic Value of a water resource. The results indicated relative importance of particular value components in determining water resources conservation preferences and individuals’ willingness for protecting them. We extract four factors (water use, production, flora and fauna and quasi-option values) and explore their influence on respondents’ WTP. Various demographic variables together with the extracted factors show a strong impact on WTP and the specific amounts stated. The study contributes to understanding of values underlying conservation decisions and help policy makers promoting strategies for protecting water resources.

On option values in environmental and resource economics

Global warming, alterations of ecosystems, and sunk investments all imply irreversible changes with uncertain future costs and benefits. The Arrow–Fisher–Hanemann–Henry quasi-option value and the Dixit–Pindyck option value both measure how irreversibility and uncertainty change the value of preserving an ecosystem or postponing an investment. This paper shows the precise relation between the two option values and explains that the quasi-option value captures the value of learning conditional on preservation, whereas the Dixit–Pindyck option value captures the net value of preservation under learning. We show how either of the two concepts alters the common net present value decision rule. We illustrate similarities, differences, and the decision rules in two instructive examples.

Economics of species change subject to risk of climate change and increasing information: a (quasi-)option value analysis

In the context of climate change, several forest adaptation options have to be advocated such as a shift to more resistant species. We provide an economic analysis of timber species change as a tool for adapting forests to climate change. We use the framework of cost–benefit analysis, taking uncertainty into account both exogenously (sensitivity analysis) and endogenously [(quasi-)option value calculations]. We apply the method to assess the economic rationale for converting Norway spruce stands to Douglas-fir in the French Black Mountain. We find that the Douglas-fir conversion is land expectation value (LEV) maximizing under a wide range of a priori (subjective) probabilities attached to high mortality of Norway spruce under climate change (for probabilities higher than 0.25–0.31). If information about the impacts of climate change is expected to increase over time, and given the large sunk costs attached to conversion, a delay strategy may be preferable to transition and to status quo when the impacts of climate change on Norway spruce mortality are sufficiently ambiguous. In such cases, getting information earlier increases the LEV by €5–60/ha. Beyond the specifics of the case study, this paper suggests that quasi-option value is a relevant tool to provide insights to forest owners dealing with adaptation decisions in the context of climate change.

Quasi-option value under strategic interactions

We consider a simple two-period model of irreversible investment under strategic interactions between two players. In this setup, we show that the quasi-option value may cause some conceptual difficulties. In case of asymmetric information, decentralized investment decisions fail to induce first-best allocations. Therefore a regulator may not be able to exercise the option to delay the decision to develop. We also show that information-induced inefficiency may arise in a game situation and that under certain assumptions inefficiency can be eliminated by sending asymmetric information to the players, even when the regulator faces informational constraints. Our model is potentially applicable to various global environmental problems.

Assessment of Regeneration Projects in Urban Areas of Environmental Interest: A Stated Choice Approach to Estimate Use and Quasi-Option Values

We adopt an attribute-based stated choice approach to evaluate public preferences over planning alternatives for an urban site of environmental interest. Since such projects involve some uncertainty and irreversibility, special attention is devoted to the estimation of quasi-option values associated with project development. Two distinct measures for the quasi-option value are estimated, and both coefficients indicate that the public place significant value on the reduction of the possibility of adverse irreversible effects: a more prudent development strategy is valued at about four times greater than a procedure that provides a greater chance of an undesired outcome. Furthermore, the study involves elicitation of intertemporal preferences over projects with different time spans, and estimation of the implicit discount rates: the values obtained seem high if compared with standard discount rates applied to public projects, but not far from interest rates on consumption found in the market.

Welfare Measures when Agents can Learn: A Unifying Theory

We extend Graham's (1981) welfare analysis under uncertainty to a dynamic environment where the agent can delay and obtain information. The dynamic willingness to pay locus unifies the concepts of option price, dynamic WTP, commitment costs and quasi-option value. Option price (dynamic WTP) corresponds to the ex ante WTP when the agent ignores (recognises) the learning opportunity. The commitment cost, or the difference between option price and dynamic WTP, equals the annualised and monetised quasi-option value. State contingent contracts have added value by allowing trading among agents with heterogeneous access to future information and delay opportunities.

Optimal conservation, extinction debt, and the augmented quasi-option value

Optimal conversion defines rules that determine the rate at which land is irreversibly moved out of conservation into production. What are the implications on these rules of allowing for a feedback between conversion decisions and the stochasticity of conservation benefits? We address this question using the well-known ecological mechanism of extinction debt as an illustration. This yields a model with a controlled-diffusion process at its core. We solve this model using a real-options approach, which leads to the conventional conversion rule as a special case. Calibrating the model to a specific case (Costa Rica), we demonstrate the presence of an augmented quasi-option value. The size of this value depends on the strength of the feedback.

A Choice Modelling Approach for Assessment of Use and Quasi-Option Values in Urban Planning for Areas of Environmental Interest

This study adopts a discrete choice modelling methodology to evaluate individuals’ preferences over planning alternatives for an urban site of environmental interest. Since such projects involve some uncertainty and irreversibility, a special attention is devoted to the estimation of the quasi-option values which are associated to project development. Two distinct measures for the quasi-option value are estimated, and both coefficients indicate that the public places a significant value on reduction of the possibility of adverse irreversible effects: a more prudent development strategy is valued about four times more than a procedure that provides a lesser hedge against undesired outcomes. Furthermore, the study involved elicitation of intertemporal preferences over projects with different time spans, and estimation of the implicit discount rates: the values obtained seem high if compared to standard discount rates applied to public projects, but not far from current interest rates on consumption.

Spatial-temporal aspects of cost-benefit analysis for park management: An example from Khao Yai National Park, Thailand

Using a model calibrated to Khao Yai National Park in Thailand, this paper highlights the importance of generating explicitly spatial and temporal data for developing management plans for tropical protected forests. Spatial and temporal cost-benefit analysis should account for the interactions between different land uses – such as the benefits of contiguous areas of preserved land and edge effects – and the realities of villagers living near forests who rely on extracted resources. By taking a temporal perspective, this paper provides a rare empirical assessment of the importance of quasi-option values when determining optimal management plans.

Utilizing and conserving agrobiodiversity in agricultural landscapes

A biodiversity-based paradigm for sustainable agriculture is a potential solution for many of the problems associated with intensive, high input agriculture, and for greater resilience to the environmental and socioeconomic risks that may occur in the uncertain future. The challenge is to understand the combined ecological and social functions of agrobiodiversity, determine its contribution to ecosystem goods and services and value for society at large, and evaluate options for the sustainable use and conservation of biodiversity across the agricultural landscape. Agrobiodiversity is most likely to enhance agroecosystem functioning when assemblages of species are added whose presence results in unique or complementary effects on ecosystem functioning, e.g., by planting genotypes with genes for higher yield or pest resistance, mixing specific genotypes of crops, or including functional groups that increase nutrient inputs and cycling. Simply adding more species to most agroecosystems may have little effect on function, given the redundancy in many groups, especially for soil organisms. The adoption of biodiversity-based practices for agriculture, however, is only partially based on the provision of ecosystem goods and services, since individual farmers typically react to the private use value of biodiversity, not the ‘external’ benefits of conservation that accrue to the wider society. Evaluating the actual value associated with goods and services provided by agrobiodiversity requires better communication between ecologists and economists, and the realization of the consequences of either overrating its value based on ‘received wisdom’ about potential services, or underrating it by only acknowledging its future option or quasi-option value. Partnerships between researchers, farmers, and other stakeholders to integrate ecological and socioeconomic research help evaluate ecosystem services, the tradeoffs of different management scenarios, and the potential for recognition or rewards for provision of ecosystem services. This paper considers ways that scientists from different disciplines can collaborate to determine the functions and value of agrobiodiversity for agricultural production, but within the context of understanding how biodiversity can be conserved in landscape mosaics that contain mixtures of land use types.

Environmental investment and valuation: a Keynesian (and Freudian) perspective

The objective of the article is to critically assess the approach taken by Basili (1994) and Vercelli (1994) towards the valuation of non-marketed environment assets. To this end, the article examines Keynes's approach to uncertainty and irrationality as influences over economic behaviour. Modern interpretations of these Keynesian insights, which have been influenced by neoclassical quantitative finance and psychological theories of decision-making, are then reviewed. A brief overview of how real options theory has been applied to the analysis of corporate investment sets the scene for a discussion of Basili and Vercelli's concept of the quasi-option values associated with the valuation of environmental assets. A 'destructive' critique is mounted against neoclassical approaches to valuation and the article concludes with a series of 'constructive' philosophical observations, drawing on Spinozian aspects of Whitehead's process philosophy.

Essays on Uncertainty and Decision-Making in Environmental Economics

This draft PhD thesis analyzes four issues in the research field that consists of the intersection of environmental economics, uncertainty, and decision-making. 1. Economic investments that lead to environmental damages beyond repair - like cutting rainforests or emitting pollutants with long life times - can be interpreted as irreversible investments with uncertain pay-offs. In the context of irreversible investments under uncertainty two different concepts of option value were developed. They account for the value of keeping options open - i.e. postponing the irreversible investment - in the presence of potential future learning about the social profitability of the investment. These are the concept of quasi-option value (value of information) developed in the environmental and resource economic literature and the concept of real option value (value of the option to postpone) developed in the financial economics literature. This thesis shows that the quasi-option value (value of information) is that part of the real option value (value of the option to postpone) that is related to uncertainty being resolved over time. This means that common knowledge in the environmental and resource economic literature with respect to the relation of both concepts is not correct. 2. If marginal damages of pollution rise with the pollution level, low marginal pollution abatement costs demand a relatively low Pigouvian tax - the pollution tax level that leads to optimal abatement. As a result, to determine the Pigouvian tax level, a regulator needs to know pollution abatement costs, information that is privately owned by individual pollutors. Unfortunately, pollutors have no intention to reveal their true abatement costs. One text book solution to this problem is that the regulator keeps adapting the tax level until the pollution tax leads to an emission level resulting in marginal damages equal to the tax level - the criterium for social optimality. That is, only after an unspecified amount of time and abatement adaptation costs the socially optimal abatement level is reached. This thesis shows there exists a non-linear tax system, the so called differential tax that triggers firms to reveal their abatement costs truthfully and will lead to socially optimal abatement levels instantly, thereby reducing social costs compared to the iterative solution. 3. In the presence of environmental innovation, future abatement costs are unknown by the polluting firms as well. Under those circumstances the regulator is needs a tax system that is flexible with respect to falling abatement costs through innovation (please recall that lower marginal abatement costs demand a lower Pigouvian tax) as well as keeps incentives for innovation - created by pollution taxes after innovation - upright. This thesis analyzes the effects of a robust second-best pollution taxation scheme that combines flexibility to cope with changing marginal abatement costs with commitment to relatively high tax levels to create incentives for environmental innovation. It shows that this instrument is superior to time consistent taxation. Superiority of the flexible taxation scheme with respect to commitment to a linear tax could not be shown. 4. The use of quantitative model results to support policy making is one way social sciences might have a positive effect on real world decision making. This thesis identifies decision-maker related potential errors made in the interpretation of quantitative model results. It is argued these errors can be prevented by the social scientist by stating explicitly for which policy maker and for what purpose the model results are meant for.

Indivisibility and divisibility in land development over time and under uncertainty

The quasi-option value (QOV) literature originated by Arrow et al. (Arrow, K.J., Fisher, A.C., 1974. Environmental preservation, uncertainty, and irreversibility. Quarterly Journal of Economics 88, 312–319) and by Henry (Henry, C., 1974. Option values in the economics of irreplaceable assets. Review of Economic Studies 41, 89–104) is largely concerned with the analysis of two-period models of land development. Our paper extends this literature by analyzing two scenarios in which the decision to develop land is made in a multi-period and stochastic framework. In the first scenario, the development decision is indivisible. In contrast, in the second scenario, the development decision is divisible. Specifically, we study the properties of the indivisible development decision when there is a time constraint on when land is to be developed. We then analyze the ways in which the divisible land development decision depends on the extent of a landowner's landholding and on the number of development opportunities awaiting this landowner.

Indivisibility and Divisibility in Land Development Over Time and Under Uncertainty

The quasi-option value (QOV) literature originated by Arrow and Fisher (1974) and by Henry (1974) is largely concerned with the analysis of two-period models of land development. Our paper extends this literature by analyzing two scenarios in which the decision to develop land is made in a multi-period and stochastic framework. In the first scenario, the development decision is indivisible. In contrast, in the second scenario, the development decision is divisible. Specifically, we study the properties of the indivisible development decision when there is a time constraint on when land is to be developed. We then analyze the ways in which the divisible land development decision depends on the extent of a landowner's landholding and on the number of development opportunities awaiting this landowner.

The Dixit–Pindyck and the Arrow–Fisher–Hanemann–Henry option values are not equivalent: a note on Fisher (2000)

Fisher (2000, this journal) offers a unifying framework for the concepts of quasi-option value, suggested by Arrow, Fisher, Hanemann, and Henry (AFHH), and the concept of real option value, suggested by Dixit and Pindyck (DP). He claims that the two concepts are equivalent. We argue that this claim is not correct. We further suggest a decomposition of the DP option value into two components, one of which corresponds exactly to the AFHH quasi-option value which captures the value of obtaining new information, and a second one which captures the postponement value irrespective of uncertainty.