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Planting Real Option in Cash Rent Valuation, The

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Author Info
Xiaodong Du
David A. Hennessy () (Center for Agricultural and Rural Development (CARD))

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Abstract

After entering into farmland rental contracts in the fall, a tenant farmer has the planting flexibility to choose between corn and soybeans. Failure to account for this switching option will bias estimates of what farmers should pay to rent land. Applying contingent claims analysis methods, this study explicitly derives the real option value function. Comparative statics with respect to the volatilities of underlying state variables and their correlations are derived and discussed. Dynamic hedging deltas in this real option context are also developed. Monte Carlo simulation results show that the average cash rent valuation for the real option approach is 11% higher than that for the conventional net present value (NPV) method. The simulated dynamic hedging deltas are shown to differ from the ones implied by the NPV method.

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Publisher Info
Paper provided by Center for Agricultural and Rural Development (CARD) at Iowa State University in its series Center for Agricultural and Rural Development (CARD) Publications with number 08-wp463.

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Date of creation: Feb 2008
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Handle: RePEc:ias:cpaper:08-wp463

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Related research
Keywords: cash rent delta hedging Monte Carlo simulation multivariate GARCH real option Ricardian rent.

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Find related papers by JEL classification:
C5 - Mathematical and Quantitative Methods - - Econometric Modeling
G1 - Financial Economics - - General Financial Markets
Q1 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture

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  1. Christopher R Cunningham, 2007. "Growth Controls, Real Options, and Land Development," The Review of Economics and Statistics, MIT Press, vol. 89(2), pages 343-358, 02. [Downloadable!] (restricted)
  2. Merton, Robert C., 1977. "On the pricing of contingent claims and the Modigliani-Miller theorem," Journal of Financial Economics, Elsevier, vol. 5(2), pages 241-249, November. [Downloadable!] (restricted)
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  4. Du, Xiaodong & Hennessy, David A. & Edwards, William M., 2007. "Determinants of Iowa Cropland Cash Rental Rates: Testing Ricardian Rent Theory," Staff General Research Papers 12845, Iowa State University, Department of Economics. [Downloadable!]
    Other versions:
  5. Quoc V. Luong & Loren W. Tauer, 2006. "A real options analysis of coffee planting in Vietnam," Agricultural Economics, International Association of Agricultural Economists, vol. 35(1), pages 49-57, 07. [Downloadable!] (restricted)
  6. Moschini, Giancarlo & Lapan, Harvey, 1995. "The Hedging Role of Options and Futures under Joint Price, Basis, and Production Risk," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(4), pages 1025-49, November. [Downloadable!] (restricted)
  7. Margaret Insley & Kimberly Rollins, 2005. "On Solving the Multirotational Timber Harvesting Problem with Stochastic Prices: A Linear Complementarity Formulation," American Journal of Agricultural Economics, American Agricultural Economics Association, vol. 87(3), pages 735-755, 08. [Downloadable!] (restricted)
  8. Kurkalova, Lyubov & Burkart, Christopher & Secchi, Silvia, 2004. "Cropland Cash Rental Rates in the Upper Mississippi River Basin," Staff General Research Papers 12204, Iowa State University, Department of Economics. [Downloadable!]
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  12. Lyubov A. Kurkalova & Christopher Burkart & Silvia Secchi, 2004. "Cropland Cash Rental Rates in the Upper Mississippi River Basin," Center for Agricultural and Rural Development (CARD) Publications 04-tr47, Center for Agricultural and Rural Development (CARD) at Iowa State University. [Downloadable!]
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  15. Bruce A. Babcock & Joseph A. Herriges, 1994. "Input Demand Under Yield and Revenue Insurance," Center for Agricultural and Rural Development (CARD) Publications 94-wp127, Center for Agricultural and Rural Development (CARD) at Iowa State University. [Downloadable!]
    Other versions:
  16. Marcus, Alan J & Modest, David M, 1984. "Futures Markets and Production Decisions," Journal of Political Economy, University of Chicago Press, vol. 92(3), pages 409-26, June. [Downloadable!] (restricted)
  17. Martin Odening & Oliver Mußhoff & Alfons Balmann, 2005. "Investment decisions in hog finishing: an application of the real options approach," Agricultural Economics, International Association of Agricultural Economists, vol. 32(1), pages 47-60, 01. [Downloadable!] (restricted)
  18. Anderson, Ronald W & Danthine, Jean-Pierre, 1983. "Hedger Diversity in Futures Markets," Economic Journal, Royal Economic Society, vol. 93(37), pages 370-89, June. [Downloadable!] (restricted)
  19. Margrabe, William, 1978. "The Value of an Option to Exchange One Asset for Another," Journal of Finance, American Finance Association, vol. 33(1), pages 177-86, March. [Downloadable!] (restricted)
  20. Sergio H. Lence & Ashok K. Mishra, 2003. "The Impacts of Different Farm Programs on Cash Rents," American Journal of Agricultural Economics, American Agricultural Economics Association, vol. 85(3), pages 753-761, 08. [Downloadable!] (restricted)
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