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In
cost–benefit analysis Cost–benefit analysis (CBA), sometimes also called benefit–cost analysis, is a systematic approach to estimating the strengths and weaknesses of alternatives. It is used to determine options which provide the best approach to achieving benefits ...
and
social welfare Welfare spending is a type of government support intended to ensure that members of a society can meet basic human needs such as food and shelter. Social security may either be synonymous with welfare, or refer specifically to social insurance p ...
economics, the term option value refers to the value that is placed on private willingness to pay for maintaining or preserving a public asset or service even if there is little or no likelihood of the individual actually ever using it. The concept is most commonly used in
public policy Public policy is an institutionalized proposal or a Group decision-making, decided set of elements like laws, regulations, guidelines, and actions to Problem solving, solve or address relevant and problematic social issues, guided by a conceptio ...
assessment to justify continuing investment in parks, wildlife refuges and land conservation, as well as rail transportation facilities and services. It is also recognized as an element of the total economic value of environmental resources. This concept of "option value" in cost–benefit analysis is different from the concept used in finance, where the term refers to the valuation of a financial instrument that provides for a future purchase of an asset. (See
Option time value In finance, the time value (TV) (''extrinsic'' or ''instrumental'' value) of an option (finance), option is the premium a rational investor would pay over its ''current'' exercise value (intrinsic value (finance), intrinsic value), based on the pro ...
.) However, the two can be related insofar as both can be interpreted as a valuation of risk factors.


Application

In the environmental research literature, option value is commonly interpreted as the value of preserving threatened
natural resources Natural resources are resources that are drawn from nature and used with few modifications. This includes the sources of valued characteristics such as commercial and industrial use, aesthetic value, scientific interest, and cultural value. ...
so that they might be available for use in the future. It has been applied for establishing the value of preserving wildlife habitats,
wilderness area Wilderness or wildlands (usually in the plural) are Earth's natural environments that have not been significantly modified by human activity, or any nonurbanized land not under extensive agricultural cultivation. The term has traditionally ...
s, and water recreation resources. In the transportation research literature, option value is most commonly interpreted as estimated the value that non-users are willing to pay to ensure continued availability of a
rail transport Rail transport (also known as train transport) is a means of transport using wheeled vehicles running in railway track, tracks, which usually consist of two parallel steel railway track, rails. Rail transport is one of the two primary means of ...
facility and its service (as an option that will be available in the future). It is recognized as a type of benefit to be considered in cost benefit evaluation of transportation investment alternatives by the UK
Department for Transport The Department for Transport (DfT) is a Departments of the Government of the United Kingdom, ministerial department of the Government of the United Kingdom. It is responsible for the English transport network and a limited number of transport ...
and the
Scottish Government The Scottish Government (, ) is the executive arm of the devolved government of Scotland. It was formed in 1999 as the Scottish Executive following the 1997 referendum on Scottish devolution, and is headquartered at St Andrew's House in ...
, and has also been used for assessment of regional rail projects in the
Netherlands , Terminology of the Low Countries, informally Holland, is a country in Northwestern Europe, with Caribbean Netherlands, overseas territories in the Caribbean. It is the largest of the four constituent countries of the Kingdom of the Nether ...
. In the US, option value is recognized in several transportation benefit-cost analysis guides, including those of the
Transportation Research Board The Transportation Research Board (TRB) is a division of the National Academies of Sciences, Engineering, and Medicine. TRB's mission is to mobilize expertise, experience, and knowledge to anticipate and solve complex transportation-related challe ...
's Committee on Transportation Economics, the Transit Cooperative Research Program, and the Victoria Transport Policy Institute.


Evolution

The term "option value" and its theoretical underpinnings as a non-user benefit were initially developed in 1964 by Burton Weisbrod. It was posited as an element of benefit distinct from the traditional concept of consumer surplus, and it depended on three factors: (1)
uncertainty Uncertainty or incertitude refers to situations involving imperfect or unknown information. It applies to predictions of future events, to physical measurements that are already made, or to the unknown, and is particularly relevant for decision ...
about future need for the asset, (2) irreversibility or high cost of replacement if the asset is lost, and (3) non-storability of the asset. That was followed by an active academic debate about the concept, and refinement of its measurement. Some economists further developed its distinction from consumer surplus and role as an
uncertainty Uncertainty or incertitude refers to situations involving imperfect or unknown information. It applies to predictions of future events, to physical measurements that are already made, or to the unknown, and is particularly relevant for decision ...
risk aversion In economics and finance, risk aversion is the tendency of people to prefer outcomes with low uncertainty to those outcomes with high uncertainty, even if the average outcome of the latter is equal to or higher in monetary value than the more c ...
premium, leading to the suggestion that a concept of "option price" may be more appropriate. Others stressed the irreversibility aspect of the resource and further specified the framework for valuing avoidance of that risk, with suggestions to adopt a concept of "quasi option value" or "irreversibility effect." All of these terms and concepts appear in academic literature. However, the original term "option value" is still commonly used in applied studies (as apparent in works cited in the preceding application section; see alsosee Johansson, Per-Olov, 1987. The Economic Theory and Measurement of Environmental Benefits, Cambridge Press).


See also

*
Cost–benefit analysis Cost–benefit analysis (CBA), sometimes also called benefit–cost analysis, is a systematic approach to estimating the strengths and weaknesses of alternatives. It is used to determine options which provide the best approach to achieving benefits ...
* Non-use value * Total economic value


References

{{DEFAULTSORT:Option value (cost-benefit analysis) Welfare economics