1932
0
  1. Home
  2. A-Z Publications
  3. Annual Review of Resource Economics
  4. Volume 11, 2019
  5. Article

Annual Review of Resource Economics

Volume 11, 2019

Real Options and Environmental Policies: The Good, the Bad, and the Ugly

Abstract

The literature on real options shows that irreversibilities, uncertainties about future benefits and costs, and the flexibility in decision making generate benefits and costs of delaying immediate action. When applied to government policy making, real option models can lead to efficient policies that take full account of these trade-offs, but they can also cause strategic behavior that tries to delay policies through influencing important elements such as downside risks. This contribution reviews the latest developments in real option–based policy research by looking at what we know about the benefits from waiting (the good), the costs from waiting (the bad), and how strategic behavior can influence policies (the ugly). Much has been said in the literature about the good and the bad, but more work is needed to study the ugly aspects of real option–driven policies.

Keyword(s): environmental policy, irreversibility, JEL C6, JEL O3, JEL Q0, precautionary principle, real options, sustainability, technological change
Loading

Article metrics loading...

/content/journals/10.1146/annurev-resource-100518-094140
2019-10-05
2024-04-25
Loading full text...

Full text loading...

/deliver/fulltext/resource/11/1/annurev-resource-100518-094140.html?itemId=/content/journals/10.1146/annurev-resource-100518-094140&mimeType=html&fmt=ahah

Literature Cited

  1. Ansar A, Flyvbjerg B, Budzier A, Lunn D 2014. Should we build more large dams? The actual costs of hydropower megaproject development. Energy Policy 6943–56
  2. Arkes HR, Blumer C. 1985. The psychology of sunk cost. Organ. Behav. Hum. Dec. 35124–40
  3. Arrow K, Cropper ML, Eads GC, Hahn RW, Lave LB et al. 1996. Is there a role for benefit-cost analysis in environmental, health, and safety regulation. Science 272221–22
  4. Arrow KJ, Dasgupta P, Goulder LH, Mumford KJ, Oleson K 2012. Sustainability and the measurement of wealth. Environ. Dev. Econ. 173317–53
  5. Arrow KJ, Fisher AC. 1974. Environmental preservation, uncertainty and irreversibility. Q. J. Econ. 882312–19
  6. Baldursson FM, von der Fehr N-HM 2004. Prices versus quantities: the irrelevance of irreversibility. Scand. J. Econ. 1064805–21
  7. Balikcioglu M, Fackler PL, Pindyck RS 2011. Solving optimal timing problems in environmental economics. Resour. Energy Econ. 33761–68
  8. Beckmann V, Soregaroli C, Wesseler JHH 2010. Ex-ante regulation and ex-post liability under uncertainty and irreversibility: governing the coexistence of GM crops. Economics 42010-9
  9. Benjamin EO, Grabenweger G, Strasser H, Wesseler JHH 2018. The socioeconomic benefits of biological control of western corn rootworm Diabrotica virgifera virgifera and wireworms Agriotes spp. in maize and potatoes for selected European countries. J. Plant Dis. Prot. 1253273–85
  10. Benjamin EO, Wesseler JHH. 2016. A socioeconomic analysis of biocontrol in integrated pest management: a review of the effects of uncertainty, irreversibility and flexibility. NJAS 7753–60
  11. Biancardi M, Villani G. 2017. A fuzzy approach for R&D compound option valuation. Fuzzy Sets Syst 310108–21
  12. Bloom N. 2009. The impact of uncertainty shocks. Econometrica 77623–85
  13. Boomsma TK, Meade N, Fleten S-E 2012. Renewable energy investments under different support schemes: a real options approach. Eur. J. Oper. Res. 220225–37
  14. Brekke KA, Oksendal B. 1994. Optimal switching in an economic activity under uncertainty. SIAM J. Control Optim. 321021–36
  15. Brookes G, Barfoot P. 2017. Environmental impacts of genetically modified (GM) crop use 1996–2015: impacts on pesticide use and carbon emissions. GM Crops Food 82117–47
  16. Buurman J, Babovic V. 2016. Adaptation pathways and real options analysis: an approach to deep uncertainty in climate change adaptation policies. Policy Soc 35137–50
  17. Carey JM, Zilberman D. 2002. A model of investment under uncertainty: modern irrigation technology and emerging markets in water. Am. J. Agric. Econ. 841171–83
  18. Carlsson C, Fuller R. 2003. A fuzzy approach to real option valuation. Fuzzy Sets Syst 139297–312
  19. Coase R. 1960. The problem of social cost. J. Law Econ. 31–44
  20. Collan M, Fullér R, Mezei J 2009. A fuzzy pay-off method for real option valuation. J. Appl. Math. Decis. Sci. 2009238196
  21. Corrigan JR, Kling CL, Zhao J 2008. Willingness to pay and the cost of commitment: an empirical specification and test. Environ. Resour. Econ. 40285–98
  22. Dangerfield CE, Whalley AE, Hanley N, Gilligan CA 2017. What a difference a stochastic process makes: epidemiological-based real options models of optimal treatment of disease. Environ. Resour. Econ. 70691–711
  23. Demers M. 1991. Investment under uncertainty, irreversibility and the arrival of information over time. Rev. Econ. Stud. 58333–50
  24. Demont M, Wesseler J, Tollens E 2004. Biodiversity versus transgenic sugar beets: the one Euro question. Eur. Rev. Agric. Econ. 3111–18
  25. Demont M, Wesseler J, Tollens E 2005. Irreversible costs and benefits of transgenic crops: What are they. Environmental Costs and Benefits of Transgenic Crops JHH Wesseler113–22 Dordrecht, Neth.: Springer
     [Google Scholar]
  26. Dittrich R, Wreford A, Moran D 2016. A survey of decision-making approaches for climate change adaptation: Are robust methods the way forward. Ecol. Econ. 12279–89
  27. Dixit AK. 1989. Entry and exit decisions under uncertainty. J. Political Econ. 973620–38
  28. Dixit AK. 1992. Investment and hysteresis. J. Econ. Persp. 61107–32
  29. Dixit AK. 1996. The Making of Economic Policy: A Transaction-Cost Politics Perspective Cambridge, MA: MIT Press
  30. Dixit AK, Pindyck RS. 1994. Investment Under Uncertainty Princeton, NJ: Princeton Univ. Press
  31. Eberly J, Rebelo S, Vincent N 2012. What explains the lagged-investment effect. J. Mon. Econ. 594370–80
  32. Epstein LG. 1980. Decision making and the temporal resolution of uncertainty. Int. Econ. Rev. 21269–83
  33. Fisher AC. 2000a. Introduction to special issue on irreversibility. Resour. Energy Econ. 22189–96
  34. Fisher AC. 2000b. Investment under uncertainty and option value in environmental economics. Resour. Energy Econ. 22197–204
  35. Fisher AC, Narain U. 2003. Global warming, endogenous risk, and irreversibility. Environ. Resour. Econ. 25395–416
  36. Frederiks C, Wesseler JHH. 2019. A comparison of the EU and US regulatory frameworks for the active substance registration of microbial biological control agents. Pest Manag. Sci. 7587–103
  37. Freixas X, Laffont JJ. 1984. On the irreversibility effect. Bayesian Models in Economic Theory M Boyer, R Kihlstrom105–14 Dordrecht, Neth.: North-Holland
     [Google Scholar]
  38. Friedman D, Pommerenke K, Lukose R, Milam G, Huberman BA 2007. Searching for the sunk cost fallacy. Exp. Econ. 1079–104
  39. Grenadier SR. 1996. The strategic exercise of options: development cascades and overbuilding in real estate markets. J. Finance 511653–79
  40. Grenadier SR. 2002. Option exercise games: an application to the equilibrium investment strategies of firms. Rev. Financ. Stud. 15691–721
  41. Grenadier SR, Wang N. 2007. Investment under uncertainty and time-inconsistent preferences. J. Financ. Econ. 842–39
  42. Hanemann WM. 1989. Information and the concept of option value. J. Environ. Econ. Manag. 1623–37
  43. Hayek F. 1944. The Road to Serfdom London: Routledge
  44. Henry C. 1974. Investment decision under uncertainty: the irreversibility effect. Am. Econ. Rev. 641006–12
  45. Herring R, Paarlberg R. 2016. The political economy of biotechnology. Annu. Rev. Resour. Econ. 8397–416
  46. Hüttel S, Musshoff O, Odening M 2010. Investment reluctance: irreversibility or imperfect capital markets. Eur. Rev. Agric. Econ. 37151–76
  47. Jones RA, Ostroy JM. 1984. Flexibility and uncertainty. Rev. Econ. Stud. 5113–32
  48. Kahneman D. 2012. Thinking, Fast and Slow New York: Farrar, Straus, & Giroux
  49. Kang SB, Létourneau P. 2016. Investors’ reaction to the government credibility problem: a real option analysis of emission permit policy risk. Energy Econ 5496–107
  50. Karp L. 2005. Global warming and hyperbolic discounting. J. Publ. Econ. 89261–82
  51. Kellogg R. 2014. The effect of uncertainty on investment: evidence from Texas oil drilling. Am. Econ. Rev. 1041698–734
  52. Kikulwe E, Falck-Zepeda J, Wesseler JHH 2014. Incremental benefits of genetically modified bananas in Uganda. Handbook on Agriculture, Biotechnology and Development D Castle, P Phillips, S Smyth 793–807 Cheltenham, UK: Edward Elgar
     [Google Scholar]
  53. Kim K, Park H, Kim H 2017. Real options analysis for renewable energy investment decisions in developing countries. Renew. Sustain. Energy Rev. 75918–26
  54. Kim K-T, Lee D-J, Pak S-J 2014. Evaluation of R&D investments in windpower in Korea using real option. Renew. Sustain. Energy Rev. 40335–47
  55. Kitzing L, Juul N, Drud M, Boomsma TK 2017. A real options approach to analyse wind energy investments under different support schemes. Appl. Energy 18883–96
  56. Kling CL, List JA, Zhao J 2013. A dynamic explanation of the willingness to pay and willingness to accept disparity. Econ. Inq. 51909–21
  57. Kolstad CD. 1996a. Fundamental irreversibilities in stock externalities. J. Publ. Econ. 60221–33
  58. Kolstad CD. 1996b. Learning and stock effects in environmental regulations: the case of greenhouse gas emissions. J. Environ. Econ. Mang. 311–18
  59. Kolstad CD, Ulen TS, Johnson GV 1990. Ex post liability for harm versus ex ante safety regulation: substitutes or compliments. Am. Econ. Rev. 80888–90
  60. Kozlova M. 2017. Real option valuation in renewable energy literature: research focus, trends and design. Renew. Sustain. Energy Rev. 80180–96
  61. Krueger AO. 1997. Trade policy and economic development: how we learn. Am. Econ. Rev. 871–22
  62. Lee S-C, Shih L-H. 2010. Renewable energy policy evaluation using real option model—the case of Taiwan. Energy Econ 32S67–78
  63. Leitzel L, Weisman E. 1999. Investing in policy reform. J. Inst. Theor. Econ. 1554696–709
  64. Lemoine DM. 2010. Valuing plug-in hybrid electric vehicles’ battery capacity using a real options framework. Energy J 31113–43
  65. Leroux AD, Martin VL, Goeschl T 2009. Optimal conservation, extinction debt, and the augmented quasi-option value. J. Environ. Econ. Manag. 5843–57
  66. Leroux AD, Whitten SM. 2014. Optimal investment in ecological rehabilitation under climate change. Ecol. Econ. 107133–44
  67. Lin TT, Ko C-C, Yeh H-N 2007. Applying real options in investment decisions relating to environmental pollution. Energy Policy 352426–32
  68. Loncar D, Milovanovic I, Rakic B, Radjenovic T 2017. Compound real options valuation of renewable energy projects: the case of a wind farm in Serbia. Renew. Sustain. Energy Rev. 75354–67
  69. Lukach R, Kort PM, Plasmans J 2007. Optimal R&D investment strategies under the threat of new technology entry. Int. J. Ind. Organ. 25103–19
  70. Markel E, Sims C, English BC 2018. Policy uncertainty and the optimal investment decisions of second-generation biofuel producers. Energy Econ 7689–100
  71. Maxwell C, Davison M. 2014. Using real option analysis to quantify ethanol policy impact on the firm's entry into and optimal operation of corn ethanol facilities. Energy Econ 42140–51
  72. Mbah MLN, Forster GA, Wesseler JHH, Gilligan CA 2010. Economically optimal timing for crop disease control under uncertainty: an options approach. J. R. Soc. Interface 71421–28
  73. McAfee RP, Mialon HM, Mialon SH 2010. Do sunk costs matter. Econ. Inq. 48323–36
  74. McDonald R, Siegel D. 1985. Investment and the valuation of firms when there is an option to shut down. Int. Econ. Rev. 26331–49
  75. McDonald R, Siegel D. 1986. The value of waiting to invest. Q. J. Econ. 101707–27
  76. Megiddo I, Drabik D, Bedford T, Morton A, Wesseler JHH, Laxminarayan R 2019. Investing in antibiotics to alleviate future catastrophic outcomes: what is the value of having an effective antibiotic to mitigate pandemic influenza. Health Econ 284556–71
  77. Merton RC. 1998. Applications of option-pricing theory: twenty-five years later. Am. Econ. Rev. 883323–49
  78. Mezey EW, Conrad JM. 2010. Real options in resource economics. Annu. Rev. Resour. Econ. 233–52
  79. Narain U, Hanemann M, Fisher A 2007. The irreversibility effect in environmental decision making. Environ. Resour. Econ. 38391–405
  80. Park H. 2012. Real option analysis for effects of emission permit banking on investment under abatement cost uncertainty. Econ. Model. 291314–21
  81. Perrings C, Brock W. 2009. Irreversibility in economics. Annu. Rev. Resour. Econ. 1219–38
  82. Pindyck RS. 2000. Irreversibilities and the timing of environmental policy. Resour. Energy Econ. 223233–59
  83. Purnhagen K. 2015. The EU's precautionary principle in food law is an information tool!. Eur. Bus. Law Rev. 6903–21
  84. Purnhagen KP, Wesseler JHH. 2019. Maximum versus minimum harmonization: what to expect from the institutional and legal battles in the EU on gene editing technologies.. Pest Manag. Sci. https://doi.org/10.1002/ps.5367
    [Crossref]
  85. Richards TJ, Green JP. 2003. Economic hysteresis in variety selection. J. Agric. Appl. Econ. 3511–14
  86. Richards TJ, Patterson PM. 1998. Hysteresis and the shortage of agricultural labor. Am. J. Agric. Econ. 804683–95
  87. Santos L, Soares I, Mendes C, Ferreira P 2014. Real options versus traditional methods to assess renewable energy projects. Renew. Energy 68588–94
  88. Schmit TM, Luo J, Conrad JM 2011. Estimating the influence of US ethanol policy on plant investment decisions: a real options analysis with two stochastic variables. Energy Econ 331194–205
  89. Schmit TM, Luo J, Tauer LW 2009. Ethanol plant investment using net present value and real options analyses. Biomass Bioenergy 331442–51
  90. Shao Q, Punt M, Wesseler JHH 2018. New plant breeding techniques under food security pressure and lobbying. Front. Plant Sci. 91324
  91. Shavell S. 1984. A model of the optimal use of liability and safety regulation. RAND J. Econ. 15271–80
  92. Shleifer A. 2010. Efficient regulation. Regulation Versus Litigation: Perspectives from Economics and Law DP Kessler 27–44 Chicago: Univ. Chicago Press
     [Google Scholar]
  93. Siddiqui A, Fleten S-E. 2010. How to proceed with competing alternative energy technologies: a real options analysis. Energy Econ 32817–30
  94. Sims C, Finnoff D. 2012. The role of spatial scale in the timing of uncertain environmental policy. J. Econ. Dyn. Control 36369–82
  95. Smart RD, Blum M, Wesseler JHH 2017. Trends in genetically engineered crops’ approval times in the United States and the European Union. J. Agric. Econ. 681182–98
  96. Smit HTJ, Trigeorgis L. 2004. Strategic Investment: Real Options and Games Princeton, NJ: Princeton Univ. Press
  97. Smyth SJ, Kerr WA, Phillips PWB 2017. Biotechnology Regulation and Trade New York: Springer
  98. Soregaroli C, Wesseler JHH. 2005. Minimum distance requirements and liability: implications for coexistence. Environmental Costs and Benefits of Transgenic Crops JHH Wesseler 165–82 Dordrecht, Neth.: Springer
     [Google Scholar]
  99. Sweis BM, Abram SV, Schmidt BJ, Seeland KD, MacDonald AW 3rd et al. 2018. Sensitivity to “sunk costs” in mice, rats, and humans. Science 361178–81
  100. Tandja MDC, Power GJ, Bastien J 2018. Real option valuation in a Gollier/Weitzman world: the effect of long-run discount rate uncertainty. Energy J 39521–53
  101. Torani K, Rausser G, Zilberman D 2016. Innovation subsidies versus consumer subsidies: a real options analysis of solar energy. Energy Policy 92255–69
  102. Tosun J, Schaub S. 2017. Mobilization in the European public sphere: the struggle over genetically modified organisms. Rev. Policy Res. 343310–30
  103. Trigeorgis L. 1996. Real Options Cambridge, MA: MIT Press
  104. Weaver R, Wesseler JHH. 2005. Monopolistic pricing power for transgenic crops when technology adopters face irreversible benefits and costs. Appl. Econ. Lett. 11969–73
  105. Wesseler JHH. 2009. The Santaniello theorem of irreversible benefits. AgBioForum 1218–13
  106. Wesseler JHH, Scatasta S, Nillesen E 2007. The Maximum Incremental Social Tolerable Irreversible Costs (MISTICs) and other benefits and costs of introducing transgenic maize in the EU-15. Pedobiologia 513261–69
  107. Wesseler JHH, Smart RD, Thomson J, Zilberman D 2017. Foregone benefits of important food crop improvements in Sub-Saharan Africa. PLOS ONE 127e0181353
  108. Wesseler JHH, Zilberman D. 2014. The economic power of the golden rice opposition. Environ. Dev. Econ. 196724–42
  109. Whitten SM, Hertzler G, Strunz S 2012. How real options and ecological resilience thinking can assist in environmental risk management. J. Risk Res. 153331–46
  110. Wilmott P, Howison S, Dewynne J 1995. The Mathematics of Financial Derivatives Cambridge, UK: Cambridge Univ. Press
  111. Wirl F. 2006. Consequences of irreversibilities on optimal intertemporal CO2 emission policies under uncertainty. Resour. Energy Econ. 28105–23
  112. Zhang K, Kleit AN. 2016. Mining rate optimization considering the stockpiling: a theoretical economics and real option model. Resour. Policy 4787–94
  113. Zhang M, Zhou D, Zhou P 2014. A real option model for renewable energy policy evaluation with application to solar PV power generation in China. Renew. Sustain. Energy Rev. 40944–55
  114. Zhao J. 2003. Irreversible abatement investment under cost uncertainties: tradable emission permits and emissions charges. J. Publ. Econ. 872765–89
  115. Zhao J, Kling CL. 2001. A new explanation for the WTP/WTA disparity. Econ. Lett. 73293–300
  116. Zhao J, Kling CL. 2003. Policy persistence in environmental regulation. Resour. Energy Econ. 25255–68
  117. Zhao J, Kling CL. 2004. Willingness to pay, compensating variation, and the cost of commitment. Econ. Inq. 42503–17
  118. Zhao J, Kling CL. 2009. Welfare measures when agents can learn: a unifying theory. Econ. J. 1191560–85
  119. Zhao J, Zilberman D. 1999. Irreversibility and restoration in natural resource development. Oxf. Econ. Pap. 51559–73
  120. Zhao J, Zilberman D. 2001. Fixed costs, efficient resource management, and conservation. Am. J. Agric. Econ. 834942–57
  121. Zilberman D, Kaplan S, Wesseler JHH 2015. The loss from underutilizing GM technologies. AgBioForum 183312–19
/content/journals/10.1146/annurev-resource-100518-094140
Loading
Real Options and Environmental Policies: The Good, the Bad, and the Ugly
Annual Review of Resource Economics 11, 43 (2019); https://doi.org/10.1146/annurev-resource-100518-094140
/content/journals/10.1146/annurev-resource-100518-094140
/content/journals/10.1146/annurev-resource-100518-094140
Loading

Data & Media loading...

  • Article Type: Review Article

Most Cited Most Cited RSS feed

This is a required field
Please enter a valid email address
Approval was a Success
Invalid data
An Error Occurred
Approval was partially successful, following selected items could not be processed due to error