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An Empirical Examination of the Relationship Between Real Options Values and the Rate of Investment in the Food and Life Science Industries

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  • Menapace, Luisa
  • Turvey, Calum G.

Abstract

This paper examines the relationship between uncertainty and investment decisions by food and non-food firms. Using hysteresis and the real options paradigm, we review why uncertainty might cause firms to delay investment. In particular, our model looks for a negative relationship between capital invested and uncertainty. In the alternative, if the relationship is positive, this may be consistent with the exercise of growth options or competitive markets. An important aspect of this paper is the development of a general economic model that imposes demand and supply shocks on the supply and demand functions, and thus allows for the derivation of a Brownian motion for prices that is a function of supply and demand elasticities, and the drifts, volatilities, and intensities of the shock variables. We show why hysteresis responses across industries with different elasticities should differ. Empirical results confirm that such differences occur. Perhaps most important, is that we find no evidence of hysteresis. In fact we find a positive relationship between changes in investment and uncertainty in profits over time. Although we use a large cross sectional, time series panel set of data, we find nothing remarkable about the food industry per se, except that across industries, their level of investment is about in the middle.

Suggested Citation

  • Menapace, Luisa & Turvey, Calum G., 2002. "An Empirical Examination of the Relationship Between Real Options Values and the Rate of Investment in the Food and Life Science Industries," 2002 Regional Committee NC-221, October 7-8, 2002, Denver, Colorado 132373, Regional Research Committee NC-1014: Agricultural and Rural Finance Markets in Transition.
    • Handle: RePEc:ags:nc2002:132373
    DOI: 10.22004/ag.econ.132373
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    References listed on IDEAS

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    1. Marcus, Alan J. & Modest, David M., 1986. "The Valuation of a Random Number of Put Options: An Application to Agricultural Price Supports," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(1), pages 73-86, March.
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    Keywords

    Agricultural Finance; Risk and Uncertainty;

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