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Jan-Henning Feil

The Effects of Different Political Schemes on the Willingness to Invest, Firm Profitability and Economic Efficiency in the Dairy Sector - An Agent- Based Real Options Approach -. Jan-Henning Feil. Overview. Motivation / Objective Theoretical Background

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Jan-Henning Feil

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  1. The Effects of Different Political Schemes on the Willingness to Invest, Firm Profitability and Economic Efficiency in the Dairy Sector- An Agent-Based Real Options Approach - Jan-Henning Feil

  2. Overview • Motivation / Objective • Theoretical Background • The Agent-Based Real Options Market Model • Results • Conclusion

  3. MotivationThe DairySector • currently strong changes in generalconditions (e.g. abolishmentofEU milk quotasystemby 2015) • extreme milk pricefluctuationsglobally in 2007, 2008 and2009 • higherlevelof (dis)investments in thedairysectorcanbeexpected • farmersandlobbyistsarecallingfor additional marketregulation (e.g. cf. European Milk Board, 2009; National Milk Producers Federation, 2009)

  4. MotivationAnalyzing Investments in theDairySector • Real Options Approach (ROA) moreadvantageousforanalyzinginvestments in thedairysectorthan Net Present Value (NPV) rule (e.g. Purviset al., 1995; Engel and Hyde, 2003; Tauer, 2006) • However: no real optionsmodelyetthatallowstheanalysisofinvestments in competitivemarketsunderconsiderationof different politicalschemes

  5. Objective • Developmentof an agent-based real optionsmarketmodelwhichallowstheanalysisof different politicalschemes in competitivemarkets in general, and in thedairysector in specific. • Comparativeanalysisoftheeffectsof • lowerpricelimitsfor milk productsmaintainedbygovernmentalpurchasesofexcesssupply • subsidiesforinvestments in milk production on investmenttriggers, firm profitabilityandeconomicefficiency.

  6. Theoretical BackgroundROA vs. NPV Rule • ROA exploitstheanalogybetween a financialoptionand an investmentproject(cf. e.g. Abel andEberly, 1994; Dixit andPindyck, 1994) • An irreversible investmentunderuncertaintyshouldonlybemade, ifthepresentvalueofitsexpectedreturnsexceedstheinvestmentcostsby an amountequaltothevalueoftheoptiontoinvestat a laterpoint in time withpossiblymoreprofit.  in comparisontothe NPV ruletheinvestmenttriggerpriceisshiftedupwards

  7. Theoretical BackgroundStochasticPrice ProcesswithoutCompetition • Source: ownelaboration

  8. Theoretical BackgroundStochastic Price ProcesswithCompetition  numerical model allowsendogenousderivationofpriceprocessandinvestmenttriggers • Source: ownelaboration

  9. The Agent-Based Real Options Market ModelBasic Assumptions • Nhomogenouscompetingrisk-neutral firms • canmakeinvestmentsupto a givenmaximumoutputcapacity • step-by-stepinvestmentpossibleoverTyears • productioncapacitycanbeadjusted via investments just once a year • irreversible investment • nodepreciation  productionoutput: nXt+∆t=nXt+nxt+∆t investmentsize in t = additional productionoutput in t+∆t

  10. The Agent-Based Real Options Market ModelInvestment BehavioroftheFirms • perfectcompetition • rational expectationsandcompleteinformation • firmswithlowertriggerpriceshave a strongertendencytoinvest • firmsaresortedaccordingtotheirtriggerpricelevel, nP* ≤ n+1P* • firm n +1 does not invest, if firm nis not alreadycompletelyinvested • in everyyear a “last“ firm invests such thatitstriggerpriceisequaltotheexpectedproductpriceofthenextperiod

  11. The Agent-Based Real Options Market ModelObjectiveFunctionfor Determination ofthe Optimal Trigger Prices P* • Maximization ofExpected NPV = Option Value: •  P*isderivedbyuseofGeneticAlgorithms

  12. The Agent-Based Real Options Market ModelObjectiveFunctionfor Determination ofthe Optimal Trigger Prices P* • Maximization ofExpected NPV = Option Value: • implementationoflowerpricelimitPMIN : • Implementation ofinvestmentsubsidys : •  P*isderivedbyuseofGeneticAlgorithms

  13. The Agent-Based Real Options Market ModelDetermination oftheEconomic Efficiency • theconceptofconsumerandproducersurplusisapplied (cf. e.g. Pindyckand Rubinfeld, 2005): • Welfarewithpoliticalschemes • Economic Efficiency (R) = • Welfarewithoutpoliticalschemes • Welfare = Consumer Surplus + Producer Surplus + State Budget • (welfareiscalculatedaspresentvalueofthewelfareof all T productionperiods)

  14. ResultsEffectsofLower Price Limits on Trigger Prices (P*), Option Values (F0) and Economic Efficiency (R) • GBM withdrift rate α = 0% andvolatilityσ = 20%, r = 6%, T = 100, Δt = 1, N = 50, k = 1,ς = -1 • PMINin relationtothe total investmentcost per outputunitandyeark = 1 • Source: ownelaboration

  15. ResultsComparisonLower Price Limits vs. Investment Subsidies • GBM withdrift rate α = 0% andvolatilityσ = 20%, r = 6%, T = 100, Δt = 1, N = 50, k = 1,ς = -1 • PMINands in relationtothe total investmentcost per outputunitandyeark = 1 • investmentsubsidyisfixedby iterative searchingatthe same triggerpricelevel • Source: ownelaboration

  16. Conclusions • conceptualbasisfor a detailedpolicyimpactanalysisforcompetitivemarketsthatunderlie real options in general, anddairysector in specific • vastmodellingflexibility • politicalschemesgenerallyincreasewillingnesstoinvest • however, they do not offeranysustainablefinancialbenefitstoproducersandreducethewelfare • investmentsubsidiesaremoreadvantageousthanlowerpricelimitsundergivenassumptions

  17. Future Research • investigateeffectsoftheabolishmentof EU milk quotasystem • besidesinvestmentsintegratedisinvestmentsintothemodel

  18. Thank you for your attention.

  19. Appendix: GeneticAlgorithms • Generateoffirstpopulationg = 1 ofNgenomesbydrawingrandomvaluesforthefirms‘ triggerprices • Determination ofoptionvaluesvia stochasticsimulation • Applicationofthe GA Operators (Fitness Evaluation  Selection & Replication  Crossover  Mutation) • Next generationg = 2 • Repeat steps 2 and 3 iteratively, untilnobetterinvestmentstrategiescanbefound 1 2 5 3 4

  20. Appendix: Determination oftheEconomic Efficiency

  21. Limitations • GBM might not be plausible forapplicationtodairysector • in reality, dairyfarmers just have limited possibilitiestoexpandproductioncapacities • assumptionofhomogenousagents  assumptionsneedtobe relaxed in futureresearch

  22. Appendix: Literature (I) Abel, A.B. and Eberly, J.C. (1994): A Unified Model of Investment under Uncertainty. American Economic Review 84: 1369-1384. Balmann, A., Happe, K. (2001): Applying parallel genetic algorithms to economic problems: the case of agricultural land markets. IIFET Conference “Microbehavior and Macroresults”. Proceedings. Corvallis, Oregon. Carey, J.M., Zilberman, D. (2002): A model of investment under uncertainty: modern irrigation technology and emerging markets in water. American Journal of Agricultural Economics 84 (1): 171-183 Dixit, A. (1991): Irreversible imvestments with price ceilings. Journal of Political Economy 99 (3): 541-557. Dixit, A. and Pindyck, R.S. (1994): Investment under Uncertainty. Princeton, US: Princeton University Press. Engel, P.D., Hyde, J. (2003): An Real Options Analysis of Automatic Milking Systems. Agricultural and Resource Economics Review32(2): 282-294. European Milk Board (2009): http://www.europeanmilkboard.org/en/special-content/news/news-details/browse/48/article/declaration-of-the-international-congress-of-non-governmental-agricultural-organizations-of-new-eu.html?tx_ttnews%5BbackPid%5D=78&cHash=0bbc4614a7 Forrest, S. (1993): Genetic algorithms: principles of natural selection applied to computation. Science 261: 872-878. Goldberg, D.E. (1989): Genetic Algorithms in Search, Optimization and Machine Learning. Reading, MA: Addison-Wesley. Holland, J.H. (1975): Adaption in Natural and Artifical Systems. Ann Arbor. MI: University of Michigan Press.

  23. Appendix: Literature (II) Leahy, J.V. (1993): Investment in Competitive Equilibrium: The Optimality of Myopic Behavior. Quarterly Journal of Economics108: 1105-1133. McDonald, R., Siegel, D. (1986): The value of waiting to invest. Quarterly Journal of Economics 101: 707-728. Mitchell, M. (1996): An Introduction to Genetic Algorithms. Cambridge, MIT Press. National Milk Producers Federation (2009): http://www.nmpf.org/files/press-releases/Price_Support_Expansion_062609.pdf Odening, M., Mußhoff, O., Balmann, A. (2005): Investment Decisions in Hog Finishing: An Application of the Real Options Approach. Agricultural Economics 32: 47-60 Pietola, K.S., Wang, H.H. (2000): The Value of Price and Quantity Fixing Contracts. European Review of Agricultural Economics27: 431-447. Pindyck, R.S., Rubinfeld, D.L. (2005): Microeconomics. Upper Saddle River, NJ: Pearson Prentice Hall. Purvis, A., Boggess, W.G., Moss, C.B., Holt, J. (1995): Technology Adoption Decisions Under Irreversibility and Uncertainty: An Ex Ante Approach. American Journal of Agricultural Economics 77: 541-551. Richards, T.J., Patterson, P.M. (1998): Hysteresis and the Shortage of Agricultural Labor. American Journal of Agricultural Economics 80(4): 683-695. Tauer, L.W. (2006):When to get in and out of dairy farming: A real option analysis. Agricultural and Resource Economics Review 35(2):339-47 Trigeorgis, L. (1996): Real Options. Cambridge, MIT Press.

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