IDEAS home Printed from https://ideas.repec.org/p/ags/cudawp/127675.html
   My bibliography  Save this paper

Stochastic Water Quality: The Timing and Option Value of Treatment

Author

Listed:
  • Conrad, Jon M.
  • Lopez, Andres

Abstract

An option-pricing model is developed to rank investments that might improve water quality. The model presumes that two investment options exist that have the potential to alter the stochastic drift of a pollutant. The investments have capital and operating costs and are irreversible once constructed. The stochastically evolving pollutant induces stochastic damage. An option-pricing model provides a criterion for determining when it is optimal to adopt the investment with the highest option value. Option value, in this model, measures the expected present value in reduced damage, relative to doing nothing. If the investments are mutually exclusive, it is possible to obtain closed-form solutions for the barriers which would trigger investment. If the investments can be sequentially adopted, a methodology is developed to calculate option values for all possible combinations of adoption dates. To illustrate the optionpricing approach, a stylized analysis of investments to protect New York City’s water supply is presented. Watershed management dominates filtration and, in the case of mutually exclusive investments, is initiated when the concentration of phosphorus reaches 22.80 μg/L.

Suggested Citation

  • Conrad, Jon M. & Lopez, Andres, 2000. "Stochastic Water Quality: The Timing and Option Value of Treatment," Working Papers 127675, Cornell University, Department of Applied Economics and Management.
  • Handle: RePEc:ags:cudawp:127675
    as

    Download full text from publisher

    File URL: http://purl.umn.edu/127675
    Download Restriction: no

    References listed on IDEAS

    as
    1. 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.
    2. Dixit, Avinash K, 1989. "Entry and Exit Decisions under Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 620-638, June.
    3. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-157, April.
    4. Kenneth J. Arrow & Anthony C. Fisher, 1974. "Environmental Preservation, Uncertainty, and Irreversibility," The Quarterly Journal of Economics, Oxford University Press, vol. 88(2), pages 312-319.
    5. Octavio A. F. Tourinho., 1979. "The Option Value of Reserves of Natural Resources," Research Program in Finance Working Papers 94, University of California at Berkeley.
    6. Ben S. Bernanke, 1983. "Irreversibility, Uncertainty, and Cyclical Investment," The Quarterly Journal of Economics, Oxford University Press, vol. 98(1), pages 85-106.
    7. Cukierman, Alex, 1980. "The Effects of Uncertainty on Investment under Risk Neutrality with Endogenous Information," Journal of Political Economy, University of Chicago Press, vol. 88(3), pages 462-475, June.
    8. Jon M. Conrad, 1997. "Global Warming: When to Bite the Bullet," Land Economics, University of Wisconsin Press, vol. 73(2), pages 164-173.
    9. Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, Oxford University Press, vol. 101(4), pages 707-727.
    10. Reed, William J & Clarke, Harry R, 1990. "Harvest Decisions and Asset Valuation for Biological Resources Exhibiting Size-Dependent Stochastic Growth," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 31(1), pages 147-169, February.
    11. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Resource /Energy Economics and Policy;

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ags:cudawp:127675. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (AgEcon Search). General contact details of provider: http://edirc.repec.org/data/dacorus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.