Alternate Decision Rules, the Flexibility Premium, and Land Development Over Time and Under Uncertainty

Abstract

The Arrow-Fisher-Henry (AFH) analysis of land development under uncertainty has been carried out in a two period model. Recently, Capozza and Helsley (1990), Batabyal (1996, 1997, 2000), and others have studied the question of land development under uncertainty in a multi-period setting. We generalize this literature by examining the role that time independent and time dependent decision rules play in the decision to develop land intertemporally and under uncertainty. We first construct a dynamic and probabilistic model of decision making in the context of land development. Next, we use this model to analyze the mean profit of a landowner when this landowner uses, respectively, time independent and time dependent decision rules. Finally, we compare and contrast the attributes of time independent and time dependent decision rules and we discuss the size of the premium stemming from the maintenance of temporal flexibility in decision making.

Keywords: Land Development, Dynamics, Uncertainty, Decision Rule

JEL Classification: Q24, D81