IS THE "STANDARD REAL OPTIONS APPROACH" APPROPRIATE FOR INVESTMENT DECISIONS IN HOG PRODUCTION?

Alfons Balmann (balmann@iamo.de) and Oliver Musshoff

No 19897, 2002 Annual meeting, July 28-31, Long Beach, CA from American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association)

Abstract: Applications of the real options approach hardly consider investment returns to be the result of competitive markets such as markets for agricultural products. The reason is probably that Dixit and Pindyck (1994, ch. 8) show in their very popular book "Investment under Uncertainty" that the investment triggers of firms in competitive markets are equal to those of firms with exclusive options. In this study, however, it is shown that this result is restricted to markets in which assets have infinite lifetime. If assets are subject to depreciation and subsequent reinvestment opportuni-ties, competition leads to significantly lower investment triggers. The reason is that depreciation of replaceable assets allows to compensate the potential decline in returns after negative demand shocks because of the non-replacement of depreciated assets. Accordingly, applications of the real options approach to investments in e.g. pig production should consider this effect. The results are obtained by an agent-based simulation approach in which a number of competing firms derive their investment triggers by a genetic algorithm. Since this method allows to understand the re-sulting price dynamics, an alternative method is presented that allows to simulate the identified price dynamics directly and which also can be used to determine investment triggers for specific conditions.

Keywords: Livestock; Production/Industries (search for similar items in EconPapers)
Pages: 19
Date: 2002
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:ags:aaea02:19897

DOI: 10.22004/ag.econ.19897

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