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Irreversible investment, uncertainty, and ambiguity: The case of bioenergy sector

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  • Elodie Le Cadre
  • Caroline Orset

Abstract

We analyse the decision of an agent to invest in industrial activities characterized by two forms of uncertainty: market size uncertainty and price uncertainty. We use bioenergy industries for an application of the model. Indeed, the sector is confronted to both, an uncertainty in relation to the arrival of an activity relying on the implementation of emerging renewable energy technology (second generation biofuel process) and an uncertainty linked to the variability of the price of biomass sold. We find the neglecting market size-related uncertainty would lead to an underestimation of the role of price uncertainty on the investment. Likewise, adding a price uncertainty may increase the investment when under both uncertainties the producer over values the selling prices. We demonstrate that the investment under price uncertainty is larger than the one under market size uncertainty when the producer's prior belief on the realization of the situation with a high price is higher than certain threshold. In addition, the ambiguity aversion on the price distribution also leads the producer to under-invest. We then discuss some political instruments that could ease the ability of the producer to invest in context of uncertainty and ambiguity.

Suggested Citation

  • Elodie Le Cadre & Caroline Orset, 2010. "Irreversible investment, uncertainty, and ambiguity: The case of bioenergy sector," Working Papers 2010/03, INRA, Economie Publique.
  • Handle: RePEc:apu:wpaper:2010/03
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    File URL: https://www6.versailles-grignon.inra.fr/economie_publique/Media/fichiers/Working-Papers/Working-Papers-2010/WP_2010_03
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    References listed on IDEAS

    as
    1. Pindyck, Robert S, 1981. " The Optimal Production of an Exhaustible Resource When Price is Exogenous and Stochastic," Scandinavian Journal of Economics, Wiley Blackwell, vol. 83(2), pages 277-288.
    2. Peter Klibanoff & Massimo Marinacci & Sujoy Mukerji, 2005. "A Smooth Model of Decision Making under Ambiguity," Econometrica, Econometric Society, vol. 73(6), pages 1849-1892, November.
    3. Dangl, Thomas, 1999. "Investment and capacity choice under uncertain demand," European Journal of Operational Research, Elsevier, vol. 117(3), pages 415-428, September.
    4. Engle Warnick James C. & Escobal Javier & Laszlo Sonia C., 2011. "Ambiguity Aversion and Portfolio Choice in Small-Scale Peruvian Farming," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 11(1), pages 1-56, November.
    5. Zengjing Chen & Larry Epstein, 2002. "Ambiguity, Risk, and Asset Returns in Continuous Time," Econometrica, Econometric Society, vol. 70(4), pages 1403-1443, July.
    6. Heath, Chip & Tversky, Amos, 1991. "Preference and Belief: Ambiguity and Competence in Choice under Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 4(1), pages 5-28, January.
    7. Kahn, Barbara E & Sarin, Rakesh K, 1988. " Modeling Ambiguity in Decisions under Uncertainty," Journal of Consumer Research, Oxford University Press, vol. 15(2), pages 265-272, September.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Ambiguity; Bioenergy; Irreversible investment; Real options theory; Uncertainty;

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • Q42 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Alternative Energy Sources
    • Q57 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Ecological Economics

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