A Note on Option Value and the Expected Value of Consumer's Surplus

Anderson Jr., R.J. (1980). A Note on Option Value and the Expected Value of Consumer's Surplus. IIASA Working Paper. IIASA, Laxenburg, Austria: WP-80-133

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Abstract

Although environmental policy decisions frequently are based on other criteria, cost-benefit analysis plays an important role in the decision-making process. Questions concerning the costs and benefits of alternative courses of action are being explored in several of REN's studies of natural resource and environmental management problems. This paper explores a general methodological problem that has arisen in applications of cost-benefit analysis of environmental resource decisions.

Several investigators claim that the usual methods of estimating the benefits of environment preservation understate systematically those benefits by an amount called "option value". Loosely put., option value is the benefit that potential (but uncertain) users of environmental services derive from avoiding the risk that these services would be unavailable. A proof has been offered that these option value benefits are always nonnegative. Other investigators have offered proofs that option value benefits may be either positive or negative and that, on a priori grounds, there is no way to determine whether or not usual benefits valuation methods systematically understate benefits of environmental preservation.

This paper attempts to reconcile these contradictory results. Helpful comments and suggestions from Jesse Ausubel, Donald Erlenkotter, and Mark Pauly are acknowledged gratefully. None of these kind individuals is to be held responsible for any errors, ambiguities, or other faults that may remain.

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