Afforestation as a real option: Choosing among options

Abstract

The theory of real options has received a considerable interest in recent years. At the core of the literature has been a so-called single-option model, i.e. a model where the decision-maker must decide the timing of a real investment given stochastic returns of the single asset in question and where the investment is a sunk cost. This paper extends the field of real-options theory by analysing the case where the decision-maker must decide on the timing of an investment facing the choice between two mutually exclusive real options with stochastic and possibly correlated returns. The paper presents a simple two-period model, outlines a continuous-time model, and presents some results of a numerical solution procedure for the case of afforestation.