What's the Option?

Posted: 28 May 2013

See all articles by Christian P. Traeger

Christian P. Traeger

University of Oslo - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute) - Ifo Institute

Date Written: January 1, 2013

Abstract

Global warming, alterations of ecosystems, and sunk investments all imply irreversible changes with uncertain future costs and benefits. The Arrow-Fisher-Hanemann-Henry quasi-option value and the Dixit-Pindyck option value both measure how irreversibility and uncertainty change the value of preserving an ecosystem or postponing an investment. This paper shows the precise relation between the two option values and explains that the quasi-option value captures the value of learning conditional on preservation, while the Dixit-Pindyck option value captures the net value of preservation under learning. We show how either of the two concepts alters the common net present value decision rule. We illustrate similarities, differences, and the decision rules in two instructive examples.

Keywords: irreversibility, option, quasi-option value, benefit cost analysis, uncertainty

JEL Classification: D81, Q51

Suggested Citation

Traeger, Christian P., What's the Option? (January 1, 2013). Available at SSRN: https://ssrn.com/abstract=2270912

Christian P. Traeger (Contact Author)

University of Oslo - Department of Economics ( email )

Norway

CESifo (Center for Economic Studies and Ifo Institute) - Ifo Institute ( email )

Poschinger Str. 5
Munich, 01069
Germany

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