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Market-based methods for monetizing uncertainty reduction

Author

Listed:
  • Roger Cooke

    (Resorses for the Future)

  • Alexander Golub

    (American University)

Abstract

New measurement systems are often expensive and need a solid economic justification. Traditional tools based on the value of information are sometimes difficult to apply. When risks are traded in a market, it may be possible to use market instruments to monetize the reductions in uncertainty. This paper illustrates such market-based methods with a satellite system designed to reduce uncertainty in predicting soil moisture in the USA. Soil moisture is a key variable in managing agricultural production and predicting crop yields. Using data on corn and soybean futures, we find that a 30% reduction in the weather-related component of uncertainty in corn and soybean futures pricing yields a yearly US consumer surplus of $1.44 billion. The total present value of information from the satellite system for the USA—calculated with a 3% discount rate—is about $22 billion, assuming the system is in operation for 20 years. The global value of the improvements in weather forecasting could be $63 billion.

Suggested Citation

  • Roger Cooke & Alexander Golub, 2020. "Market-based methods for monetizing uncertainty reduction," Environment Systems and Decisions, Springer, vol. 40(1), pages 3-13, March.
    • Handle: RePEc:spr:envsyd:v:40:y:2020:i:1:d:10.1007_s10669-019-09748-w
    DOI: 10.1007/s10669-019-09748-w
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    References listed on IDEAS

    as
    1. Westcott, Paul C. & Jewison, Michael, 2013. "Weather Effects on Expected Corn and Soybean Yields," Agricultural Outlook Forum 2013 146846, United States Department of Agriculture, Agricultural Outlook Forum.
    2. paolo pianca, 2005. "Simple Formulas to Option Pricing and Hedging in the Black- Scholes Model," Finance 0511005, University Library of Munich, Germany.
    3. Nicky J. Welton & Howard H. Z. Thom, 2015. "Value of Information," Medical Decision Making, , vol. 35(5), pages 564-566, July.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Zachary A. Collier & James H. Lambert & Igor Linkov, 2020. "Interdisciplinary mathematical methods for societal decision-making and resilience," Environment Systems and Decisions, Springer, vol. 40(1), pages 1-2, March.
    2. Derek Lemoine & Sarah Kapnick, 2024. "Financial markets value skillful forecasts of seasonal climate," Nature Communications, Nature, vol. 15(1), pages 1-10, December.
    3. Bokolo Anthony, 2023. "Decentralized brokered enabled ecosystem for data marketplace in smart cities towards a data sharing economy," Environment Systems and Decisions, Springer, vol. 43(3), pages 453-471, September.

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    More about this item

    Keywords

    Value of information; Options pricing; SMAP; Bachelier formula; Black–Scholes-Merton model;
    All these keywords.

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • C44 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Operations Research; Statistical Decision Theory
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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