Irreversible investment, uncertainty, and ambiguity: The case of bioenergy sector

Elodie Le Cadre and Caroline Orset

No 2010/03, Working Papers from INRA, Economie Publique

Abstract: We analyse the decision of an agent to invest in industrial activities characterized by two forms of uncertainty: market size uncertainty and price uncertainty. We use bioenergy industries for an application of the model. Indeed, the sector is confronted to both, an uncertainty in relation to the arrival of an activity relying on the implementation of emerging renewable energy technology (second generation biofuel process) and an uncertainty linked to the variability of the price of biomass sold. We find the neglecting market size-related uncertainty would lead to an underestimation of the role of price uncertainty on the investment. Likewise, adding a price uncertainty may increase the investment when under both uncertainties the producer over values the selling prices. We demonstrate that the investment under price uncertainty is larger than the one under market size uncertainty when the producer's prior belief on the realization of the situation with a high price is higher than certain threshold. In addition, the ambiguity aversion on the price distribution also leads the producer to under-invest. We then discuss some political instruments that could ease the ability of the producer to invest in context of uncertainty and ambiguity.

Keywords: Ambiguity; Bioenergy; Irreversible investment; Real options theory; Uncertainty (search for similar items in EconPapers)
JEL-codes: D21 D81 Q42 Q57 (search for similar items in EconPapers)
Date: 2010-03-01
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