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Discounting, Disagreement, and the Option to Delay

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  • Graeme Guthrie

    (Victoria University of Wellington)

Abstract

Evaluating the benefits of investment projects related to climate change is complicated by disagreements surrounding the discount rate. It is widely known that greater discount-rate heterogeneity increases the weighted-average present value of investing if the weighted-average discount rate is held constant, which therefore reduces the minimum internal rate of return needed to justify now-or-never investment. A larger adjustment is appropriate for projects with longer lives. I extend this analysis in two directions, first by giving the decision-maker the option to delay investment. Greater discount-rate heterogeneity also increases the weighted-average present value of the option to wait and reevaluate investment in the future. This weakens the relationship between discount-rate heterogeneity and the optimal investment threshold—and in some cases actually reverses it. When discount rates are low and the project’s lifetime is short, increases in discount-rate heterogeneity can lead to tougher (not easier) optimal investment tests. The second extension examines the effect on these results of using different approaches to aggregate opinions about the discount rate, including the $$\alpha$$ α -maxmin, minimax-regret, and multi-utilitarian criteria.

Suggested Citation

  • Graeme Guthrie, 2021. "Discounting, Disagreement, and the Option to Delay," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 80(1), pages 95-133, September.
    • Handle: RePEc:kap:enreec:v:80:y:2021:i:1:d:10.1007_s10640-021-00580-y
    DOI: 10.1007/s10640-021-00580-y
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    More about this item

    Keywords

    Social discount rate; Cost-benefit analysis; Real-options analysis; Discount-rate heterogeneity; Climate change;
    All these keywords.

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming
    • R42 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Transportation Economics - - - Government and Private Investment Analysis; Road Maintenance; Transportation Planning

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