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A General Equilibrium Model of Environmental Option Values

Author

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  • Iain Fraser

    ()

  • Katsuyuki Shibayama

    ()

Abstract

In this paper we consider the option value of the environment employing a general equilibrium growth model with a stochastic technology. In our model, as in existing studies, because of irreversibility, the environment has significant real option value. However, unlike the existing literature in which the uncertainty of the value of the environment is given exogenously, the value of the environment is endogenously determined. In our model, the elasticity of substitution eta between the environment and consumption plays a crucial role. We show that the option value, and hence, the optimal decision are both affected by eta not only quantitatively but also qualitatively.

Suggested Citation

  • Iain Fraser & Katsuyuki Shibayama, 2011. "A General Equilibrium Model of Environmental Option Values," Studies in Economics 1107, School of Economics, University of Kent.
  • Handle: RePEc:ukc:ukcedp:1107
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    Keywords

    real option values; environment; general equilibrium; elasticity of substitution;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • Q31 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Demand and Supply; Prices

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