EQUIVALENT OPTION PRICE WITH SUPPLY UNCERTAINTY
Article first published online: 6 FEB 2013
© 2013 The Author. Bulletin of Economic Research © 2013 Blackwell Publishing Ltd and the Board of Trustees of the Bulletin of Economic Research.
Bulletin of Economic Research
How to Cite
Shafran, A. P. (2013), EQUIVALENT OPTION PRICE WITH SUPPLY UNCERTAINTY. Bulletin of Economic Research. doi: 10.1111/boer.12000
- Article first published online: 6 FEB 2013
- cost benefit analysis;
- option price;
- project evaluation;
- supply uncertainty
This paper compares two ex ante measures of the benefits of a project with supply uncertainty: compensating option price, the willingness to pay for a project, and equivalent option price, the willingness to accept to forego a project. The paper shows that compensating option price does not generally rank three or more projects correctly, even when the projects only impose a change in a single good. Equivalent option price, like equivalent variation with certain outcomes, always ranks three or more projects correctly. This paper also presents a method to empirically estimate equivalent option price using estimates of the benefits of certain changes. This approach is practically important so that the same study results can be used to estimate equivalent option price even as new projects are developed or as changes occur in the scientific information regarding the probabilities of various project outcomes. An application of the empirical method estimates the benefits of a policy to improve air and water quality when there is uncertainty about the effectiveness of the policy.