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 conducted in a two period model. others have analyzed the question of land development under uncertainty in a multi-period setting. We extend this literature by examining the role that time independent and time dependent decision rules play in the decision to develop land over time and under uncertainty. We first construct a dynamic and stochastic model of decision making in the context of land development. Next, we use this model to analyze the expected profit of a landowner when this landowner uses, respectively, time independent and time dependent decision rules. Finally, we compare and contrast the properties of time independent and time dependent decision rules and we discuss the magnitude of the premium stemming from the maintenance of temporal flexibility in decision making.