The Dixit-Pindyck and the Arrow-Fisher-Hanemann-Henry Option Values are not Equivalent

Mensink, Paul; Requate, Till

doi:10.2139/ssrn.405062

Cited by 7 publications

(5 citation statements)

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“…8 This value can be decomposed into the value of immediately trying and giving birth and the value of having the option to try and give birth later. Note that there is no information accruing in time, meaning that this option value, which we call "option value of giving birth" corresponds to the "pure postponement value" defined by Mensink and Requate (2005), as opposed to the option value for receiving information or "quasi-option value", which is the concept developed by Arrow, Fisher, Hanemann, and Henry (see Arrow and Fisher (1974), Henry (1974), and Fisher and Hanemann (1987)). This pure postponement value is however part of the Dixit-Pindyck option (see Dixit (1992), Pindyck (1991), and Dixit and Pindyck (1994)) which is the sum of the pure postponement value and of the quasi-option value.…”

Section: Age At Birthmentioning

confidence: 99%

Childbearing postponement, its option value, and the biological clock

Croix¹,

Pommeret

2021

Journal of Economic Theory

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Having children is like investing in a risky project. Postponing birth is like delaying an irreversible investment. It has an option value, which depends on its costs and benefits, and in particular on the additional risks motherhood brings. We develop a parsimonious theory of childbearing postponement along these lines. We derive its implications for asset accumulation, income, optimal age at first birth, and childlessness. The structural parameters are estimated by matching the predictions of the model to data from the National Longitudinal Survey of Youth NLSY79. The uncertainty surrounding income growth is shown to increase with childbearing, and this increase is stronger for more educated people. This effect alone can explain why the age at first birth and the childlessness rate both increase with education. We use the model to simulate two hypothetical policies. Providing free medically assisted reproduction technology does not affect the age at first birth much, but lowers the childlessness rate. Insuring mothers against income risk is powerful in lowering the age at first birth.

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Section: Age At Birthmentioning

confidence: 99%

Childbearing postponement, its option value, and the biological clock

Croix¹,

Pommeret

2021

Journal of Economic Theory

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“…According to a 2011 Energy Commerce Committee report, BTEX compounds --benzene, toluene, ethylbenzene, and xylene, all known carcinogens -appeared in at least 60 fracking products in use between 2005 and 2009. in a dynamic programming application, and Dixit and Pindyck (1994) bring the real options approach to the mainstream environmental and resource economics literature. Mensink and Requate (2005) point out that the Dixit and Pindyck option value (DPOV) and the QOV are not necessarily equivalent. Specifically, they find that when postponement is initially beneficial and the net present value of a project is strictly positive, the DPOV captures the QOV in addition to the value created from doing the project in a later period in the absence of learning.…”

Section: Fracking Damagesmentioning

confidence: 99%

“…Traeger (2014) extends Mensink and Requate (2005) and provides a general relationship between QOV and DPOV: the QOV is the value of learning conditional on postponement and the DPOV is the net value of postponement under learning. The literature proves two important properties of the QOV that are relevant to our model.…”

Section: Learning About Environmental Risksmentioning

confidence: 99%

Uncertainty, learning, and local opposition to hydraulic fracturing

Hess

Manning

Iverson

et al. 2019

Resource and Energy Economics

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The development of oil and gas extraction technologies, including hydraulic fracturing (fracking), has increased fossil fuel reserves in the US. Despite benefits, uncertainty over environmental damages has led to fracking bans, both permanent and temporary, in many jurisdictions. We develop a stochastic dynamic learning model parameterized with a computable general equilibrium model to explore if uncertainty about damages, combined with the ability to learn about risks, can explain fracking bans in practice. Applying the model to a representative Colorado municipality, we quantify the quasi-option value (QOV), which creates an additional incentive to ban fracking temporarily in order to learn, though it only influences policy in a narrow range of oil and gas prices. To our knowledge, this is the first attempt to quantify an economy-wide QOV associated with a local environmental policy decision.

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“…Grappling with the theoretical distinction was muddied further by the fact that financial economics has yet another concept of option value, developed for application to natural resource economics by Dixit and Pindyck (1994). Fortunately, a number of authors, particularly Hanemann (1989), Mensink and Requate (2005), and Traeger (2014), have provided unifying syntheses of and clarity among these three distinct concepts. Furthermore, terminology appears to have evolved to distinguish between the 'Arrow-Fisher-Henry' quasi-option value and the 'Dixit-Pindyck' option value.…”

Section: Introductionmentioning

confidence: 99%

Mining with Environmental Risk

Costello

Kolstad

2015

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We study the timing-of-extraction problem facing a decentralized mine owner when extraction entails environmental damage. As expected, when the environmental damage from mining is known, the socially optimal timing will depend on the magnitude of the damage relative to these costs in the rest of the world. But when environmental damage is uncertain, and these costs are revealed over time, a quasi-option value arises. We show that even if expected environmental costs are identical to those in the rest of the world, any uncertainty over these costs will cause the social planner to optimally delay mining until better information arrives. We show conditions under which it is optimal to postpone the mining decision indefinitely, and conditions when it is optimal to postpone only for a finite duration. The analysis leverages a crucial observation that distinguishes the non-renewable resource problem from the traditional quasi-option value framework. In the traditional framework, the presence of an irreversible investment and uncertainty can help nudge the decision maker to preserve an option, but it by no means implies the decision maker should always preserve the option. In contrast, for a non-renewable resource model, the arbitrage condition underpinning the Hotelling rule suggests that in the absence of uncertainty, the marginal mine owner is completely indifferent between mining immediately and at any point in the future. Thus, for our problem, any uncertainty will convince her to defer the mining decision. AbstractWe study the timing-of-extraction problem facing a decentralized mine owner when extraction entails environmental damage. As expected, when the environmental damage from mining is known, the socially optimal timing will depend on the magnitude of the damage relative to these costs in the rest of the world. But when environmental damage is uncertain, and these costs are revealed over time, a quasi-option value arises. We show that even if expected environmental costs are identical to those in the rest of the world, any uncertainty over these costs will cause the social planner to optimally delay mining until better information arrives. We show conditions under which it is optimal to postpone the mining decision indefinitely, and conditions when it is optimal to postpone only for a finite duration. The analysis leverages a crucial observation that distinguishes the non-renewable resource problem from the traditional quasi-option value framework. In the traditional framework, the presence of an irreversible investment and uncertainty can help nudge the decision maker to preserve an option, but it by no means implies the decision maker should always preserve the option. In contrast, for a non-renewable resource model, the arbitrage condition underpinning the Hotelling rule suggests that in the absence of uncertainty, the marginal mine owner is completely indifferent between mining immediately and at any point in the future. Thus, for our problem, any uncertainty will convince her to defer the mining decision...

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The Dixit-Pindyck and the Arrow-Fisher-Hanemann-Henry Option Values are not Equivalent

Cited by 7 publications

References 0 publications

Childbearing postponement, its option value, and the biological clock

Childbearing postponement, its option value, and the biological clock

Uncertainty, learning, and local opposition to hydraulic fracturing

Mining with Environmental Risk

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