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Planting Real Option in Cash Rent Valuation, The

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Abstract

After entering into farmland rental contracts in the fall, a tenant farmer has the planting flexibility to choose between corn and soybeans. Failure to account for this switching option will bias estimates of what farmers should pay to rent land. Applying contingent claims analysis methods, this study explicitly derives the real option value function. Comparative statics with respect to the volatilities of underlying state variables and their correlations are derived and discussed. Dynamic hedging deltas in this real option context are also developed. Monte Carlo simulation results show that the average cash rent valuation for the real option approach is 11% higher than that for the conventional net present value (NPV) method. The simulated dynamic hedging deltas are shown to differ from the ones implied by the NPV method.

Suggested Citation

  • Xiaodong Du & David A. Hennessy, 2008. "Planting Real Option in Cash Rent Valuation, The," Center for Agricultural and Rural Development (CARD) Publications 08-wp463, Center for Agricultural and Rural Development (CARD) at Iowa State University.
    • Handle: RePEc:ias:cpaper:08-wp463
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    1. Vedenov, Dmitry V., 2008. "Application of Copulas to Estimation of Joint Crop Yield Distributions," 2008 Annual Meeting, July 27-29, 2008, Orlando, Florida 6264, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
    2. Tejeda, Hernan A. & Goodwin, Barry K., 2008. "Modeling Crop prices through a Burr distribution and Analysis of Correlation between Crop Prices and Yields using a Copula method," 2008 Annual Meeting, July 27-29, 2008, Orlando, Florida 6061, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
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    Cited by:

    1. David Ubilava, 2012. "Modeling Nonlinearities in the U.S. Soybean‐to‐Corn Price Ratio: A Smooth Transition Autoregression Approach," Agribusiness, John Wiley & Sons, Ltd., vol. 28(1), pages 29-41, January.
    2. Miao, Ruiqing & Khanna, Madhu, 2015. "The Biomass Crop Assistance Program: Critical, Notional, or Distortional Support for Cellulosic Biofuels?," 2015 AAEA & WAEA Joint Annual Meeting, July 26-28, San Francisco, California 205818, Agricultural and Applied Economics Association.
    3. Ruiqing Miao & Madhu Khanna, 2017. "Effectiveness of the Biomass Crop Assistance Program: Roles of Behavioral Factors, Credit Constraint, and Program Design," Applied Economic Perspectives and Policy, Agricultural and Applied Economics Association, vol. 39(4), pages 584-608.
    4. Miao, Ruiqing & Khanna, Madhu, 2017. "Costs of meeting a cellulosic biofuel mandate with perennial energy crops: Implications for policy," Energy Economics, Elsevier, vol. 64(C), pages 321-334.
    5. Majeed, Fahd & Khanna, Madhu & Miao, Ruiqing & Betes, Elena Blanc & Hudiburg, Tara & DeLucia, Evan, 2022. "Payment for carbon mitigation reduces riskiness of bioenergy crop production," 2022 Annual Meeting, July 31-August 2, Anaheim, California 322277, Agricultural and Applied Economics Association.
    6. Clark Lundberg & Ryan Abman, 2022. "Maize price volatility and deforestation," American Journal of Agricultural Economics, John Wiley & Sons, vol. 104(2), pages 693-716, March.
    7. Mohit Anand & Ruiqing Miao & Madhu Khanna, 2019. "Adopting bioenergy crops: Does farmers’ attitude toward loss matter?," Agricultural Economics, International Association of Agricultural Economists, vol. 50(4), pages 435-450, July.

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    More about this item

    Keywords

    cash rent; delta hedging; Monte Carlo simulation; multivariate GARCH; real option; Ricardian rent.;
    All these keywords.

    JEL classification:

    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • G1 - Financial Economics - - General Financial Markets
    • Q1 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture

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