Are the Dixit-Pindyck and the Arrow-Fisher-Henry-Hanemann Option Values Equivalent?

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Are the Dixit-Pindyck and the Arrow-Fisher-Henry-Hanemann Option Values Equivalent?

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Iulie Aslaksen and Terje Synnestvedt () (Statistics Norway)

Abstract

The relationship between the concept of option value in the literature on environmental preservation and the financial theory of option value is discussed by Fisher (2000), suggesting an equivalence between the two concepts. In a recent paper, Mensink and Requate (2004) argue that Fisher’s claim is incorrect. In this paper we clarify Fisher’s argument by drawing on the article by Hanemann (1989), whereby we find the conditions for the Arrow-Fisher-Henry-Hanemann (AFHH) and the Dixit-Pindyck (DP) option value concepts to coincide or not. The main point is that the AFHH option value is derived under the assumption that investment does not take place in the first period, neither in the closed-loop nor in the open-loop strategy, whereas the analysis of the DP option value is based on the assumption that investment in the open-loop strategy takes place in the first period.

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Paper provided by Research Department of Statistics Norway in its series Discussion Papers with number 390.

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Date of creation: Sep 2004
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Handle: RePEc:ssb:dispap:390

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Find related papers by JEL classification:
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
Q20 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - General

This paper has been announced in the following NEP Reports:

NEP-ALL-2004-11-22 (All new papers)
NEP-MIC-2004-11-22 (Microeconomics)

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Dixit, Avinash, 1992. "Investment and Hysteresis," Journal of Economic Perspectives, American Economic Association, vol. 6(1), pages 107-32, Winter. [Downloadable!] (restricted)
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. [Downloadable!] (restricted)
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. [Downloadable!] (restricted)
Henry, Claude, 1974. "Investment Decisions Under Uncertainty: The "Irreversibility Effect."," American Economic Review, American Economic Association, vol. 64(6), pages 1006-12, December. [Downloadable!] (restricted)

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