Solving Real Options Models of Fisheries Investment When Salvage Value Is Difficult to Estimate

Abstract

Real options models arguably provide a useful framework for understanding individual fishermen’s investment and participation decisions, which play an important role in fisheries management issues ranging from capacity reduction to stock assessment. While these models appear to predict actual behavior reasonably well, one important difficulty in applying them is that the salvage value of the fishing enterprise (or the opportunity cost of fishing, which when capitalized can be treated as a salvage value) is often difficult to assess. For example, there may be few sales in a market for boats or licenses, and there may be little information on other employment opportunities available to fishermen. This paper adopts a fisherman’s exit decision as a framework for exploring solution techniques for real options models when salvage value is difficult to estimate. We first present a simple model of the exit decision as a disinvestment problem, and then describe this model’s solution by minimization and finite difference methods, including an iterative nonlinear least squares approach that allows rapid solution for a wide range of putative deterministic salvage values. We then allow salvage value to follow its own stochastic process, again exploring this example with both minimization and finite difference techniques. Our general conclusion is that minimization methods are much preferable when they apply, but that in most fisheries applications it will be necessary to resort to finite difference, finite element, or Monte Carlo methods. (Click here for the paper)

Source: Tomberlin, D. and V. Bosetti. 2004. “Solving Real Options Models of Fisheries Investment When Salvage Value Is Difficult to Estimate.” In: Proceedings of the Twelfth Biennial Conference of the International Institute of Fisheries Economics & Trade: What are Responsible Fisheries? July 20-30, 2004, Tokyo, Japan. Corvallis, OR: International Institute for Fisheries Economics and Trade (IIFET).

For more information, please contact: David.Tomberlin@noaa.gov