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Entry of Alternative Fuels in a Volatile U.S. Gasoline Market

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  • Vedenov, Dmitry V.
  • Duffield, James A.
  • Wetzstein, Michael E.
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    Abstract

    The hypothesis underlying this analysis is that in the presence of volatile gasoline prices competitive market forces will yield alternative, less volatile fuels as substitutes. A real-option pricing approach was employed for this analysis by modeling investment under uncertainty for the case of comparing stochastic prices of substitute commodities. Based on real options, threshold decision rules were developed for the adoption of portfolio fuels such as ethanol and conventional gasoline blends. Considering this portfolio effect, the benefit-to-cost ratios are above four for the alternative blends under varying discount rates and time horizons. This provides a strong indication that consumer demand exists for these portfolio fuels. Competitive markets will then respond to this consumer demand yielding less volatile portfolio fuels and incorporating ethanol into domestic fuel mix.

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    File URL: http://purl.umn.edu/19182
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    Bibliographic Info

    Paper provided by American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association) in its series 2005 Annual meeting, July 24-27, Providence, RI with number 19182.

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    Date of creation: 2005
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    Handle: RePEc:ags:aaea05:19182

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    Keywords: Resource /Energy Economics and Policy;

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    1. Peter Ferderer, J., 1996. "Oil price volatility and the macroeconomy," Journal of Macroeconomics, Elsevier, vol. 18(1), pages 1-26.
    2. Kneller, Richard & Young, Garry, 2001. "Business Cycle Volatility, Uncertainty and Long-Run Growth," Manchester School, University of Manchester, vol. 69(5), pages 534-52, Special I.
    3. James G. MacKinnon, 1992. "Approximate Asymptotic Distribution Functions for Unit Roots and Cointegration Tests," Working Papers 861, Queen's University, Department of Economics.
    4. Robert S. Pindyck, 1999. "The Long-Run Evolutions of Energy Prices," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2), pages 1-27.
    5. Sadorsky, Perry, 1999. "Oil price shocks and stock market activity," Energy Economics, Elsevier, vol. 21(5), pages 449-469, October.
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