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Investment decisions in hog finishing: an application of the real options approach

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  • Martin Odening
  • Oliver Mu�hoff
  • Alfons Balmann

Abstract

In this paper, option-pricing theory is applied to an investment problem in hog production. A stochastic simulation model capable of pricing American-type options is developed. This is achieved by recursive calculation of the exercise frontier. The model is used to determine the investment trigger and the disinvestment trigger for a pig-fattening barn under German market conditions. It turns out that the investment trigger, taking into account the value of waiting in an uncertain environment, can be considerably higher compared to classical investment criteria such as the net present value. This offers an explanation as to why farmers are indeed reluctant to invest in hog production. Another finding is the sensitivity of the option prices with respect to the stochastic process that is assumed for revenues and variable costs of the production activity. Copyright 2005 International Association of Agricultural Economics.

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Bibliographic Info

Article provided by International Association of Agricultural Economists in its journal Agricultural Economics.

Volume (Year): 32 (2005)
Issue (Month): 1 (01)
Pages: 47-60

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Handle: RePEc:bla:agecon:v:32:y:2005:i:1:p:47-60

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Cited by:
  1. Wossink, Ada & Kuminoff, Nicolai V., 2005. "Valuing the Option to Switch to Organic Farming: An Application to U.S. Corn and Soybeans," 2005 International Congress, August 23-27, 2005, Copenhagen, Denmark, European Association of Agricultural Economists 24716, European Association of Agricultural Economists.
  2. Tubetov, Dulat & Maart, Syster Christin & Musshoff, Oliver, 2012. "Comparison of the Investment Behavior of German and Kazakhstani Farmers: an Experimental Approach," Discussion Papers, Georg-August-Universitaet Goettingen, GlobalFood, Department of Agricultural Economics and Rural Development 122422, Georg-August-Universitaet Goettingen, GlobalFood, Department of Agricultural Economics and Rural Development.
  3. Niemi, Jarkko K., 2012. "Designing coordination contracts to support efficient flow-scheduling in pork chain," 2012 Annual Meeting, August 12-14, 2012, Seattle, Washington, Agricultural and Applied Economics Association 125208, Agricultural and Applied Economics Association.
  4. McClintock, Anthea, 2009. "Investment in irrigation technology: an application of real options analysis," 2009 Conference (53rd), February 11-13, 2009, Cairns, Australia, Australian Agricultural and Resource Economics Society 47934, Australian Agricultural and Resource Economics Society.
  5. J.M. Bewley & M.D. Boehlje & A.W. Gray & H. Hogeveen & S.J. Kenyon & S.D. Eicher & M.M. Schutz, 2010. "Stochastic simulation using @Risk for dairy business investment decisions," Agricultural Finance Review, Emerald Group Publishing, Emerald Group Publishing, vol. 70(1), pages 97-125, May.
  6. Lee, Sangjun & Zhao, Jinhua & Thornsbury, Suzanne, 2013. "Extreme Events and Land Use Decisions under Climate Change in Tart Cherry Industry in Michigan," 2013 Annual Meeting, August 4-6, 2013, Washington, D.C., Agricultural and Applied Economics Association 150568, Agricultural and Applied Economics Association.
  7. Sandri, Serena & Schade, Christian & Mußhoff, Oliver & Odening, Martin, 2010. "Holding on for too long? An experimental study on inertia in entrepreneurs' and non-entrepreneurs' disinvestment choices," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 76(1), pages 30-44, October.
  8. Tubetov, Dulat & Maart, Syster Christin & Musshoff, Oliver, 2012. "The comparison of investment behaviors of Kazakhstani and German farmers: An experimental approach," 86th Annual Conference, April 16-18, 2012, Warwick University, Coventry, UK, Agricultural Economics Society 134770, Agricultural Economics Society.
  9. Odening, Martin & Musshoff, Oliver & Huettel, Silke, 2003. "Empirische Validierung von Realoptionsmodellen," Working Paper Series, Humboldt University Berlin, Department Agricultural Economics 18825, Humboldt University Berlin, Department Agricultural Economics.
  10. Breustedt, Gunnar & Mees, Martin, 2010. "Growth Of German Dairy Farms Under The Eu Milk Quota," 50st Annual Conference, Braunschweig, Germany, September 29-October 1, 2010, German Association of Agricultural Economists (GEWISOLA) 93950, German Association of Agricultural Economists (GEWISOLA).
  11. Tubetov, Dulat & Maart, Syster Christin & Musshoff, Oliver, 2012. "Experimental examination of land investment decisions with volatile returns A comparison between Kazakhstani and German farmers," 123rd Seminar, February 23-24, 2012, Dublin, Ireland, European Association of Agricultural Economists 122454, European Association of Agricultural Economists.
  12. Simone Pieralli & Silke Hüttel & Martin Odening, 2013. "A model of firm exit under inefficiency and uncertainty," EcoMod2013 5236, EcoMod.
  13. Musshoff, Oliver & Hirschauer, Norbert, 2004. "Die Berücksichtigung von Unsicherheit und Flexibilität in der Investitionsplanung – dargestellt am Beispiel einer Vertragsinvestition für Roggen," German Journal of Agricultural Economics, Humboldt-Universitaet zu Berlin, Department for Agricultural Economics, Humboldt-Universitaet zu Berlin, Department for Agricultural Economics, vol. 53(4).
  14. Musshoff, Oliver & Hirschauer, Norbert, 2008. "Investment planning under uncertainty and flexibility: the case of a purchasable sales contract," Australian Journal of Agricultural and Resource Economics, Australian Agricultural and Resource Economics Society, Australian Agricultural and Resource Economics Society, vol. 52(1), March.
  15. Maart, Syster Christin & Musshoff, Oliver & Odening, Martin & Schade, Christian, 2011. "Closing down the Farm: An Experimental Analysis of Disinvestment Timing," 2011 International Congress, August 30-September 2, 2011, Zurich, Switzerland, European Association of Agricultural Economists 114375, European Association of Agricultural Economists.
  16. Niemi, Jarkko K. & Liu, Xing & Pietola, Kyosti, 2011. "Price volatility and return on pig fattening under different price- quantity contract regimes," 2011 International Congress, August 30-September 2, 2011, Zurich, Switzerland, European Association of Agricultural Economists 114614, European Association of Agricultural Economists.
  17. Tubetov, Dulat & Musshoff, Oliver & Kellner, Ulla, 0. "Investments in Kazakhstani Dairy Farming: A Comparison of Classical Investment Theory and the Real Options Approach," Quarterly Journal of International Agriculture, Humboldt-Universität zu Berlin, Humboldt-Universität zu Berlin, vol. 51.
  18. Feil, Jan-Henning & Musshoff, Oliver, 2012. "Policy Impact Analysis on Investments and Disinvestments under Competition: A Real Options Approach," 2012 Conference (56th), February 7-10, 2012, Freemantle, Australia, Australian Agricultural and Resource Economics Society 124294, Australian Agricultural and Resource Economics Society.
  19. Ihli, Hanna Julia & Maart, Syster Christin & Musshoff, Oliver, 2012. "Investment and Disinvestment in Irrigation Technology – An Experimental Analysis of Farmers’ Decision Behavior –," 2012 Annual Meeting, August 12-14, 2012, Seattle, Washington, Agricultural and Applied Economics Association 124532, Agricultural and Applied Economics Association.
  20. Maart, Syster Christin & Musshoff, Oliver & Odening, Martin & Schade, Christian, 2010. "Zum Desinvestitionsverhalten Landwirtschaftlicher Unternehmer: Ergebnisse Einer Experimentellen Untersuchung," 50st Annual Conference, Braunschweig, Germany, September 29-October 1, 2010, German Association of Agricultural Economists (GEWISOLA) 93943, German Association of Agricultural Economists (GEWISOLA).
  21. Llop Llop, Maria & Ponce Alifonso, Xavier,, 2012. "Agriculture, technological change and environmental sustainability: Looking for a win-win water policy strategy," Working Papers 2072/203158, Universitat Rovira i Virgili, Department of Economics.

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