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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.

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.

Suggested Citation

  • Vedenov, Dmitry V. & Duffield, James A. & Wetzstein, Michael E., 2005. "Entry of Alternative Fuels in a Volatile U.S. Gasoline Market," 2005 Annual meeting, July 24-27, Providence, RI 19182, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
  • Handle: RePEc:ags:aaea05:19182
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    References listed on IDEAS

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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 534-552, Special I.
    3. 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.
    4. MacKinnon, James G, 1994. "Approximate Asymptotic Distribution Functions for Unit-Root and Cointegration Tests," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(2), pages 167-176, April.
    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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    Keywords

    Resource /Energy Economics and Policy;

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