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Pest - Resistance Development of Transgenic Crops

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Justus WesselerMonterey, CA USAJune 24-27, 2002IIIIf it is assumed that the incremental net-benefits B of releasing transgenic crops follow a mean reverting process, they should be released immediately if B is greater than the identified hurdle rate for a mean reverting process. As B may also follow a geometric Brownian motion that dominates the mean reverting process the additional uncertainty of the difference between the two stochastic processes, the scientific uncertainty, , can be added, resulting in a hurdle rate :ValueAcknowledgementsThe Option Value of Scientific Uncertainty on Pest - Resistance Development ofTransgenic CropsbyJustus WesselerAssistant ProfessorEnvironmental Economics and Natural Resources Group, Social Sciences Department, Wageningen University, Hollandseweg 1, 6706KN Wageningen, The NetherlandsPhone: +31 317 482300, Fax: +31 317 484933, e-mail: [email protected] prepared for presentation at the 2nd World Congress of Environmental and Resource EconomistsMonterey, CA USAJune 24-27, 2002Abstract. In this paper the option value of waiting under scientificuncertainty will be derived using the difference between the geometricBrownian motion and the mean reverting process by applying contingentclaim analysis. The results will be compared with those generated byeither using a geometric Brownian motion or a mean-reverting processonly. An example based on the decision problem whether or not to releaseherbicide tolerant rape seed in the EU will be used to illustrate thedifferences. The paper contributes to the suggestion made by biologists tofurther analyze the sensitivity of the results using the real option approach,provides insights about the magnitude of error that can be made bychoosing the wrong process, provides a solution to the problem andhighlights the implication for the decision of whether or not to releasetransgenic crops. The results show that scientific uncertainty is lessimportant than one would expect at first hand.Keywords: biotechnology, cost-benefit analysis, real option, scientific uncertainty.JEL: Q, D81, D61.The Option Value of Scientific Uncertainty on Pest - Resistance Development ofTransgenic Crops1. IntroductionEconomists have proposed the real option theory for the ex-ante valuation of costs andbenefits from transgenic crops. Farrow, Morel, Wu and Casman (2001) in their papermodel the uncertain incremental net-benefits from transgenic crops by using ageometric Brownian motion process1. The build up of pest resistance is included byadding a jump process describing the decay of resistance. Irreversibilities, I, areexplained by possible gene drifts from transgenic crops. Wesseler and Weichert (1999)and Wesseler (2002) used almost the same approach. Wesseler (id.) included in thelater paper the possibility of irreversible benefits, R. Irreversible benefits were definedas the reduction of irreversible costs of the alternative technology. Gilligan (2002) in areview of Farrow et al. (id.) and Wesseler (id.) argued that further discussion on thesensitivity of the results is needed in a dialogue with biologists. One assumption madein both papers is that resistance is inevitable. This does not necessarily have to be thecase. As Gilligan (id.) clearly pointed out gene drift may lead to invasion but invasionmay not lead to persistence and pest resistance may occur but may also break downagain over time. That is to say that there is not only uncertainty about the economicvariables but also uncertainty about the biological processes. This adds uncertainty tothe models used by Farrow et al. and Wesseler and will have two effects. On the onehand, this will lead to uncertain irreversible costs; on the other hand it will affect theincremental net-benefits from transgenic crops. 1 The incremental net-benefits are the differences between transgenic and non-transgenic crops.Let’s ignore for a while the uncertainties about the irreversible costs byassuming they are constant2, and concentrate on the incremental net-benefits.If the incremental net-benefits of a transgenic crop will be negatively affectedover time due to invasion, they will decrease, if not, it can be assumed they willcontinue to grow. Both situations are not unfamiliar to economists. A geometricBrownian motion can model the uncertain growth as has been done by Farrow et al.(id.) and Wesseler (id.). If pest resistance occurs, the decrease over time can bemodeled by using a mean reverting process. The problem then would be to decidewhich kind of process to use. A solution to the problem would be simple if by using an appropriateeconometric method time series data could be tested to decide which process to use.As Dixit and Pindyck (1994) and others (e.g. Gjolberg and Guttormsen, 2002) havepointed out the results are ambiguous. Depending on the time frame used, the testseither lead to a rejection or acceptance of a non-stationary process. They recommendchoosing the process not based on time series analysis but based on theoreticalgrounds. This is a straightforward recommendation, if scientists can agree about therelevant theory. But as the case for transgenic crops shows (Gilligan id.), there is noscientific certainty about the stochastic benefits from transgenic crops. Scientists areaware of the problem, but have no method available that tells them which model tochoose. This is what in this context will be called scientific uncertainty. From a decision makers point of view this may not be important if differentprocesses do not lead to different recommendations. As Wesseler (2001) has pointedout, the choice of a stochastic process may but not necessarily will lead to differentrecommendations. Figure 1 shows a comparison between a geometric Brownianmotion and a mean reverting process and the decision to release transgenic crops,2 That this is a useful assumption has been explained by Wesseler (id.).where it is assumed that each process represents a scientific belief or view about thebenefits from transgenic crops. The situations depicted under quadrant I and quadrantIV lead to unequivocal decisions: either immediate release, quadrant I, or delaying therelease, quadrant IV. On the other, hand


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