Quasi Option Value and Irreversible Choices

25 Pages Posted: 8 Jul 2001

See all articles by Valentina Bosetti

Valentina Bosetti

Bocconi University; CMCC - Euro Mediterranean Centre for Climate Change

E. Messina

Università degli Studi di Milano-Bicocca

Date Written: January 2001

Abstract

In this paper we are concerned with optimal investment decisions when dealing with land allocation problems. We aim to emphasise the importance of flexible modelling in order to capture irreversibility. In particular, we stretch a discrete model, firstly developed in Coggins and Ramezani (Coggins & Ramezzani, 1998), in order to cover a more realistic and complex scenario. Both environmental and economic uncertainty are included in the model and treated using an integrated approach, in which decision analysis techniques and option pricing theory are jointly applied to evaluate development versus conservation opportunities. Moreover, we take explicit account of how uncertainty interacts with two types of irreversibility: sunk costs associated with investment in developing decisions, including environmental and social costs due to environmental degradation, as well as sunk costs associated to environmental regulation and conservation. Finally, we use the Quasi Option Value, to derive decision rules that account for different levels of flexibility of land allocation possibilities.

Keywords: Uncertainty, irreversibility, environment, land allocation

JEL Classification: Q30, Q20, D81

Suggested Citation

Bosetti, Valentina and Messina, E., Quasi Option Value and Irreversible Choices (January 2001). FEEM Fondazione Eni Enrico Mattei Research Paper Series, Forthcoming, Available at SSRN: https://ssrn.com/abstract=275131 or http://dx.doi.org/10.2139/ssrn.275131

Valentina Bosetti (Contact Author)

Bocconi University

Via Gobbi 5
Milan, 20136
Italy

CMCC - Euro Mediterranean Centre for Climate Change

via Augusto Imperatore, 16
Lecce, I-73100
Italy

E. Messina

Università degli Studi di Milano-Bicocca

Piazza dell'Ateneo Nuovo 1
Milano, Milan
Italy

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