Option Values and the Choice of Trade Agreements
This paper analyzes how uncertainty influences the formation and design of regional trade agreements (TAs). Two sources of uncertainty â€” in demand and costs â€” are considered. Using a multi-stage game we show that, as long as some decisions are made after uncertainty is resolved, all TAs have option values. But, because TAs differ in their flexibility and degrees of coordination these option values vary across TAs. Thus, under uncertainty, the usual cost/benefit analysis that underlies the formation and design of TAs is altered to reflect these option values. We also show that due to the flexibility and coordination differences among TAs, their option values are affected differently by uncertainty. Consequently, the formation and design of TAs is also affected by the nature and degree of uncertainty. We demonstrate that the effects of an increase in uncertainty on the choice of TAs depend on the relative responsiveness of the TAsâ€™ option values with respect to the change in uncertainty, which in turn depends on the convexity properties of the countriesâ€™ welfare functions under the different TAs. In particular, a TA whose option value is more responsive to a change in uncertainty becomes relatively more attractive when uncertainty increases. This enables us to predict which TAs are likely to emerge in an uncertain world. Using a specific example, we then show the effects of a change in both demand and cost uncertainty on the choice of TAs. We also examine the timing of the resolution of uncertainty and its effect on the choice of TAs and show that it can significantly impact the type of trade agreement that countries wish to form.
|Date of creation:||18 Feb 2014|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: (416) 736-5083
Fax: (416) 736-5987
Web page: http://dept.econ.yorku.ca/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- MARTIN, Alberto & VERGOTE, Wouter, 2007.
"On the role of retaliation in trade agreements,"
CORE Discussion Papers
2007089, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- MARTIN, Alberto & VERGOTE, Wouter, . "On the role of retaliation in trade agreements," CORE Discussion Papers RP -2037, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- Alberto Martin & Wouter Vergote, 2005. "On the role of retaliation in trade agreements," Economics Working Papers 914, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 2008.
- Mas-Colell, Andreu & Whinston, Michael D. & Green, Jerry R., 1995. "Microeconomic Theory," OUP Catalogue, Oxford University Press, number 9780195102680, March.
- Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
- Jennifer Pédussel Wu, 2005. "Trade Agreements as Self-Protection," Review of International Economics, Wiley Blackwell, vol. 13(3), pages 472-484, 08.
- Wilfred J. Ethier, 2002. "Unilateralism in a Multilateral World," Economic Journal, Royal Economic Society, vol. 112(479), pages 266-292, April.
- Carlo Perroni & John Whalley, 2000.
"The new regionalism: trade liberalization or insurance?,"
Canadian Journal of Economics,
Canadian Economics Association, vol. 33(1), pages 1-24, February.
- Carlo Perroni & John Whalley, 1994. "The New Regionalism: Trade Liberalization or Insurance?," NBER Working Papers 4626, National Bureau of Economic Research, Inc.
- Bruno Bassan & Olivier Gossner & Marco Scarsini & Shmuel Zamir, 2003.
"Positive value of information in games,"
International Journal of Game Theory,
Springer, vol. 32(1), pages 17-31, December.
- Bruno Bassan & Olivier Gossner & Marco Scarsini & Shmuel Zamir, 2001. "Positive value of information in games," Discussion Paper Series dp294, The Federmann Center for the Study of Rationality, the Hebrew University, Jerusalem, revised Jul 2002.
- Bruno Bassan & Olivier Gossner & Marco Scarsini & Shmuel Zamir, 2001. "Positive value of information in games," ICER Working Papers - Applied Mathematics Series 26-2003, ICER - International Centre for Economic Research, revised Jul 2003.
- Hirshleifer, Jack, 1971. "The Private and Social Value of Information and the Reward to Inventive Activity," American Economic Review, American Economic Association, vol. 61(4), pages 561-74, September.
- Raymond RIEZMAN, 2013.
"Customs Unions and the Core,"
World Scientific Book Chapters,
in: International Trade Agreements and Political Economy, chapter 3, pages 33-43
World Scientific Publishing Co. Pte. Ltd..
- Peski, Marcin, 2008. "Comparison of information structures in zero-sum games," Games and Economic Behavior, Elsevier, vol. 62(2), pages 732-735, March.
- Grant, Simon & Quiggin, John, 1997. "Strategic Trade Policy under Uncertainty: Sufficient Conditions for the Optimality of Ad Valorem, Specific and Quadratic Trade Taxes," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 38(1), pages 187-203, February.
- Kamien, Morton I. & Tauman, Yair & Zamir, Shmuel, 1990. "On the value of information in a strategic conflict," Games and Economic Behavior, Elsevier, vol. 2(2), pages 129-153, June.
- repec:cup:cbooks:9780521827478 is not listed on IDEAS
When requesting a correction, please mention this item's handle: RePEc:yca:wpaper:2014_1. 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: (Support)
If references are entirely missing, you can add them using this form.