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On option values in environmental and resource economics

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  • Traeger, Christian P.

Abstract

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.

Suggested Citation

  • Traeger, Christian P., 2014. "On option values in environmental and resource economics," Resource and Energy Economics, Elsevier, vol. 37(C), pages 242-252.
    • Handle: RePEc:eee:resene:v:37:y:2014:i:c:p:242-252
    DOI: 10.1016/j.reseneeco.2014.03.001
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    1. Fujii, Tomoki & Ishikawa, Ryuichiro, 2013. "Arrow-Fisher-Hanemann-Henry and Dixit-Pindyck Option Values Under Strategic Interactions," Strategic Behavior and the Environment, now publishers, vol. 3(3), pages 169-183, March.
    2. Kenneth J. Arrow & Anthony C. Fisher, 1974. "Environmental Preservation, Uncertainty, and Irreversibility," Palgrave Macmillan Books, in: Chennat Gopalakrishnan (ed.), Classic Papers in Natural Resource Economics, chapter 4, pages 76-84, Palgrave Macmillan.
    3. Claude Henry, 1974. "Investment decisions under uncertainty: The "irreversibility effect"," ULB Institutional Repository 2013/327343, ULB -- Universite Libre de Bruxelles.
    4. Hanemann, W. Michael, 1989. "Information and the concept of option value," Journal of Environmental Economics and Management, Elsevier, vol. 16(1), pages 23-37, January.
    5. Henry, Claude, 1974. "Investment Decisions Under Uncertainty: The "Irreversibility Effect."," American Economic Review, American Economic Association, vol. 64(6), pages 1006-1012, December.
    6. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    7. Mensink, Paul & Requate, Till, 2005. "The Dixit-Pindyck and the Arrow-Fisher-Hanemann-Henry option values are not equivalent: a note on Fisher (2000)," Resource and Energy Economics, Elsevier, vol. 27(1), pages 83-88, January.
    8. Jon M. Conrad, 1980. "Quasi-Option Value and the Expected Value of Information," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 94(4), pages 813-820.
    9. Fisher, Anthony C., 2000. "Investment under uncertainty and option value in environmental economics," Resource and Energy Economics, Elsevier, vol. 22(3), pages 197-204, July.
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    Cited by:

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    2. Kotchen, Matthew J. & Costello, Christopher, 2018. "Maximizing the impact of climate finance: Funding projects or pilot projects?," Journal of Environmental Economics and Management, Elsevier, vol. 92(C), pages 270-281.
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    6. Anne van Aaken & Janis Antonovics & Susan Rose-Ackerman, 2016. "The Limits of Cost/Benefit Analysis When Disasters Loom," Global Policy, London School of Economics and Political Science, vol. 7, pages 56-66, May.
    7. Bogmans, Christian W.J. & Dijkema, Gerard P.J. & van Vliet, Michelle T.H., 2017. "Adaptation of thermal power plants: The (ir)relevance of climate (change) information," Energy Economics, Elsevier, vol. 62(C), pages 1-18.
    8. Christopher Costello & Charles D. Kolstad, 2015. "Mining with Environmental Risk," NBER Working Papers 21325, National Bureau of Economic Research, Inc.
    9. Lewis, David J. & Polasky, Stephen, 2018. "An auction mechanism for the optimal provision of ecosystem services under climate change," Journal of Environmental Economics and Management, Elsevier, vol. 92(C), pages 20-34.
    10. Gerling, Charlotte & Schöttker, Oliver & Hearne, John, 2022. "Irreversible and partly reversible investments in the optimal reserve design problem: the role of flexibility under climate change," MPRA Paper 112089, University Library of Munich, Germany.

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    More about this item

    Keywords

    Irreversibility; Option; Quasi-option value; Benefit cost analysis; Uncertainty;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • Q51 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Valuation of Environmental Effects

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