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Evaluating Environmental Investments: A Real Options Approach

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Author Info

  • Gonzalo Cortazar

    (Departamento Ingeniería Industrial y de Sistemas, Pontificia Universidad Católica de Chile)

  • Eduardo S. Schwartz

    (Anderson Graduate School of Management, University of California at Los Angeles, Los Angeles, California 90095-1481)

  • Marcelo Salinas

    (Departamento Ingeniería Industrial y de Sistemas, Pontificia Universidad Católica de Chile)

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    Abstract

    The paper presents a model that determines when (at which output price level) it is optimum for a firm to invest in environmental technologies and which are the main parameters that affect this decision. Our analysis shows that firms require high output price levels to be induced to invest in environmental technologies, because they optimally would not want to commit to a heavy irreversible investment that could turn out to be unprofitable in the event of a price fall. A comparative static analysis predicts that firms in industries with high output price volatility would be more reluctant to invest in environmental protection technologies and would be more willing to operate at low output levels (thus attaining low emission levels). Increases in the interest rate would also reduce optimal environmental investment levels.

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    File URL: http://dx.doi.org/10.1287/mnsc.44.8.1059
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    Bibliographic Info

    Article provided by INFORMS in its journal Management Science.

    Volume (Year): 44 (1998)
    Issue (Month): 8 (August)
    Pages: 1059-1070

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    Handle: RePEc:inm:ormnsc:v:44:y:1998:i:8:p:1059-1070

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    Related research

    Keywords: Real Options; Environmental Economics; Capital Budgeting; Natural Resources;

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    Citations

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    Cited by:
    1. Andrea Gamba & Lenos Trigeorgis, 2007. "An Improved Binomial Lattice Method for Multi-Dimensional Options," Applied Mathematical Finance, Taylor & Francis Journals, vol. 14(5), pages 453-475.
    2. Murillas Maza, Arantza, 2000. "Uncertainty and Real Options. Investment and Development of Fishing Resources (I)," BILTOKI 2000-01, Universidad del País Vasco - Departamento de Economía Aplicada III (Econometría y Estadística).
    3. Antonio Roma & Davide Pirino, 2008. "A Theoretical Model for the Extraction and Refinement of Natural Resources," Department of Economics University of Siena 537, Department of Economics, University of Siena.
    4. Lambie, N. Ross, 2009. "The role of real options analysis in the design of a greenhouse gas emissions trading scheme," 2009 Conference (53rd), February 11-13, 2009, Cairns, Australia 47626, Australian Agricultural and Resource Economics Society.
    5. Collan, Mikael, 2004. "Giga-Investments: Modelling the Valuation of Very Large Industrial Real Investments," MPRA Paper 4328, University Library of Munich, Germany.
    6. Takizawa, Shinichiro, 2010. "Private monitoring games and decisions under uncertainty," Economics Letters, Elsevier, vol. 108(3), pages 337-340, September.
    7. Andrea Gamba, 2002. "Real options Valuation: A Monte Carol Approach," Working Papers wpn02-02, Warwick Business School, Finance Group.
    8. Dean Paxson, 2007. "Sequential American Exchange Property Options," The Journal of Real Estate Finance and Economics, Springer, vol. 34(1), pages 135-157, January.
    9. Takizawa, Shinichiro, 2008. "The effect of decisions under uncertainty on imperfect monitoring games," Economics Letters, Elsevier, vol. 100(2), pages 165-168, August.
    10. Roma, Antonio & Pirino, Davide, 2009. "The extraction of natural resources: The role of thermodynamic efficiency," Ecological Economics, Elsevier, vol. 68(10), pages 2594-2606, August.
    11. Timo Busch & Volker Hoffmann, 2009. "Ecology-Driven Real Options: An Investment Framework for Incorporating Uncertainties in the Context of the Natural Environment," Journal of Business Ethics, Springer, vol. 90(2), pages 295-310, December.
    12. Fernandes, Bartolomeu & Cunha, Jorge & Ferreira, Paula, 2011. "The use of real options approach in energy sector investments," Renewable and Sustainable Energy Reviews, Elsevier, vol. 15(9), pages 4491-4497.
    13. Robert Kast, 2011. "Managing financial risks due to natural catastrophes," Working Papers hal-00610241, HAL.
    14. Murillas Maza, Arantza, 2000. "Uncertainty and Real Options. Investment and Development of Fishing Resources (II)," BILTOKI 2000-02, Universidad del País Vasco - Departamento de Economía Aplicada III (Econometría y Estadística).
    15. Fernando Oliveira, 2010. "Bottom-up design of strategic options as finite automata," Computational Management Science, Springer, vol. 7(4), pages 355-375, October.

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