Real options analysis for land use management: Methods, application, and implications for policy. (15th September 2015)

• Record Type: Journal Article
• Authors: Regan, Courtney M.; Bryan, Brett A.; Connor, Jeffery D.; Meyer, Wayne S.; Ostendorf, Bertram; Zhu, Zili; Bao, Chenming
• Is Part Of: Journal of environmental management. Volume 161(2015)
• Page Start: 144
• Page End: 152
• Publication Date: 2015-09-15
• Subjects: Land use -- Real options -- Agriculture -- Planning -- Economic; Environmental policy -- Periodicals; Environmental management -- Periodicals; Environment -- Periodicals; Ecology -- Periodicals; 363.705
• DOI: 10.1016/j.jenvman.2015.07.004
• Languages: English
• ISSNs: 0301-4797

Abstract

Abstract: Discounted cash flow analysis, including net present value is an established way to value land use and management investments which accounts for the time-value of money. However, it provides a static view and assumes passive commitment to an investment strategy when real world land use and management investment decisions are characterised by uncertainty, irreversibility, change, and adaptation. Real options analysis has been proposed as a better valuation method under uncertainty and where the opportunity exists to delay investment decisions, pending more information. We briefly review the use of discounted cash flow methods in land use and management and discuss their benefits and limitations. We then provide an overview of real options analysis, describe the main analytical methods, and summarize its application to land use investment decisions. Real options analysis is largely underutilized in evaluating land use decisions, despite uncertainty in policy and economic drivers, the irreversibility and sunk costs involved. New simulation methods offer the potential for overcoming current technical challenges to implementation as demonstrated with a real options simulation model used to evaluate an agricultural land use decision in South Australia. We conclude that considering option values in future policy design will provide a more realistic assessment of landholder investment decision making and provide insights for improved policy performance. Highlights: We review the literature on Real Options Analysis (ROA) in land use investments. ROA is more realistic than net present value in land use change cost estimation. The complexity of ROA methods have been a barrier to their adoption. New simulation methods offer potential for overcoming current technical challenges. We illustrate this potential with a ROA application to a land use policy simulation.