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Bringing Social Standards into Project Evaluation Under Dynamic Uncertainity

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  • Odin K. Knudsen

    ()
    (World Bank)

  • Pasquale Lucio Scandizzo

    ()
    (University of Rome)

Abstract

Society often sets social standards that define thresholds of damage to society or the environment above which compensation must be paid to the state or other parties. In this paper, we analyze the interdependence between the use of social standards and investment evaluation under dynamic uncertainty where a negative externality above a threshold established by society requires an assessment and payment of damages. Under uncertainty, the party considering implementing a project or new technology must not only assess when the project is economically efficient to implement but when to abandon a project that could potentially exceed the social standard. Using real option theory and simple models, we demonstrate how such a social standard can be integrated into cost-benefit analysis through the use of a development option and a liability option coupled with a damage function. Uncertainty, in fact, implies that both parties interpret the social standard as a target for safety rather than an inflexible barrier that cannot be overcome. The larger is the uncertainty, in fact, the greater will be the tolerance for damages in excess of the social standard from both parties.

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Bibliographic Info

Paper provided by Tor Vergata University, CEIS in its series CEIS Research Paper with number 63.

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Length: 24
Date of creation: 07 Dec 2004
Date of revision:
Handle: RePEc:rtv:ceisrp:63

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Postal: CEIS - Centre for Economic and International Studies - Faculty of Economics - University of Rome "Tor Vergata" - Via Columbia, 2 00133 Roma
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  1. Bohm, Peter, 1975. "Option Demand and Consumer's Surplus: Comment," American Economic Review, American Economic Association, American Economic Association, vol. 65(4), pages 733-36, September.
  2. Arrow, Kenneth J & Fisher, Anthony C, 1974. "Environmental Preservation, Uncertainty, and Irreversibility," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 88(2), pages 312-19, May.
  3. Pasquale L. Scandizzo & Odin Knudsen, 1996. "Social Supply and the Evaluation of Food Policies," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, Agricultural and Applied Economics Association, vol. 78(1), pages 137-145.
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Cited by:
  1. Pasquale Lucio Scandizzo & Odin K Knudsen, 2010. "Risk Management and Regulation Compliance with Tradable Permits under Dynamic Uncertainty," CEIS Research Paper, Tor Vergata University, CEIS 163, Tor Vergata University, CEIS, revised 28 May 2010.
  2. Scandizzo, Pasquale L. & Ventura, Marco, 0. "Bids for the UMTS system: An empirical evaluation of the Italian case," Telecommunications Policy, Elsevier, Elsevier, vol. 30(10-11), pages 533-551, November.
  3. Giuseppe Pennisi & Pasquale L. Scandizzo, 2006. "Economic Evaluation in the age of Uncertainty," CEIS Research Paper, Tor Vergata University, CEIS 86, Tor Vergata University, CEIS.

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