Water Resources Management

, Volume 23, Issue 10, pp 1989–2001 | Cite as

A Socioeconomic Valuation of an Irrigation System Project Based on Real Option Analysis Approach

  • Anastasios Michailidis
  • Konstadinos Mattas
  • Irene Tzouramani
  • Diamantis Karamouzis


Traditional net present value methods used to evaluate potential projects make no allowance for flexibility and assume a static environment. The concept of real options has extended into irrigation systems to model design flexibility in the realistically uncertain environment. In particular, this article extends the evaluation techniques of an irrigation dam by combining the real options approach along with the traditional on (Discount Cash Flow). However, whereas financial options are well-defined traded contracts, real options in irrigation systems are a priori undefined, complex and interdependent. Moreover, irrigation systems involve many more options than designers could consider. Therefore designers need to identify the real options most likely to offer good flexibility and the most value. This paper demonstrates the ease that irrigation systems economic analysis with risk analysis and real options can be valued by simulation software that is readily available to owners of personal computers. Sequentially, Discount Cash Flow analysis accompanied with real options approach facilitates decision making and encourages more sophisticated and realistic economic analysis of irrigation systems.


Crop water requirements Expected yield Irrigation systems Monte Carlo simulation Net present value Real options 


Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.


  1. Amram M, Kulatilaka N (1999) Real options: managing strategic investment in an uncertain world. Harvard Business School Press, Boston, MAGoogle Scholar
  2. Bjerksund P, Ekern S (1990) Managing investment opportunities under price uncertainty: from ‘last chance’ to wait and see strategies. Financ Manag 19:65–83. doi:10.2307/3665826 CrossRefGoogle Scholar
  3. Black F, Scholes M (1973) The pricing of options and corporate liabilities. J Polit Econ 3:637–654. doi:10.1086/260062 CrossRefGoogle Scholar
  4. Brealey AR, Myers SC (1991) Principles of corporate finance, 4th edn. McGraw-Hill, New YorkGoogle Scholar
  5. Brennan MJ, Trigeorgis L (2000) Project flexibility, agency, and competition. Oxford University Press, USAGoogle Scholar
  6. Carey JM, Zilberman D (2002) A model of investment under uncertainty: modern irrigation technology and emerging markets in water. Am J Agric Econ 84(1):171–183. doi:10.1111/1467-8276.00251 CrossRefGoogle Scholar
  7. Demers M (1991) Investment under uncertainty, irreversibility and the arrival of information over time. Rev Econ Stud 58:333–350. doi:10.2307/2297971 CrossRefGoogle Scholar
  8. Dixit A (1992) Investment and hysteresis. J Econ Perspect 6(1):107–132Google Scholar
  9. Dixit A, Pindyck RS (1994) Investment under uncertainty. Princeton University Press, Princeton, NJGoogle Scholar
  10. Dixit A, Pindyck RS (1995) The options approach to capital investment. Harv Bus Rev 73:105–115Google Scholar
  11. Gittinger JP (1986) Economic analysis of agricultural projects, international bank for reconstruction and development. The John Hopkins University Press, BaltimoreGoogle Scholar
  12. Ingersoll JE, Ross SA (1992) Waiting to invest: investment and uncertainty. J Bus 65:1–30. doi: 10.1086/296555 CrossRefGoogle Scholar
  13. Kassarr I, Lasserre P (2004) Species preservation and biodiversity value: a real options approach. J Environ Econ Manage 48(2):857–879. doi:10.1016/j.jeem.2003.11.005 CrossRefGoogle Scholar
  14. Kemna AGZ (1993) Case studies in real options. Financ Manag 22:16–27CrossRefGoogle Scholar
  15. Louberge H, Villeneuve S, Chesney M (2002) Long-term risk management of nuclear waste: a real options approach. J Econ Dyn Control 27(1):157–180. doi:10.1016/S0165-1889(01)00058-6 CrossRefGoogle Scholar
  16. Luehrman TA (1998) Investment opportunities as real options: getting started on the numbers. Harv Bus Rev 76:51–67Google Scholar
  17. Michailidis A, Mattas K (2007) Using real options theory to irrigation dam investment analysis: an application of binomial option pricing model. Water Resour Manag 21:1717–1733. doi:10.1007/s11269-006-9122-3 CrossRefGoogle Scholar
  18. Morck R, Schwartz E, Stangeland D (1989) The valuation of forestry resources under stochastic prices and inventories. J Financ Quant Anal 24:473–487. doi:10.2307/2330980 CrossRefGoogle Scholar
  19. Paddock JL, Siegel DR, Smith JL (1987) Valuing offshore oil properties with option pricing models. Midl Corp Finance J 5:22–30Google Scholar
  20. Palisade Corporation (1998) BEST FIT: distribution fitting software package. Version 2, Newfield, NYGoogle Scholar
  21. Palisade Corporation (2000) RISK risk analysis and simulation add-in for microsoft excel: a software package. Version 4, Newfield, NYGoogle Scholar
  22. Panigrahi B, Panda SN, Agrawal A (2005) Water balance simulation and economic analysis for optimal size of on-farm reservoir. Water Resour Manag 19:233–250. doi:10.1007/s11269-005-2701-x CrossRefGoogle Scholar
  23. Pindyck RS (1991) Irreversibility, uncertainty and investment. J Econ Lit 29:1110–1148Google Scholar
  24. Purvis A, Boggess WG, Moss CB, Holt J (1995) Technology adoption decisions under irreveribility and uncertainty: an ex ante approach. Am J Agric Econ 77:541–551. doi:10.2307/1243223 CrossRefGoogle Scholar
  25. Yang C, Chen X, Xu J (2008) A method to optimize gross fixed capital investment for water conservancy in China. Econ Syst Res 20:151–172. doi:10.1080/09535310802075331 CrossRefGoogle Scholar
  26. Zhang H (2008) The analysis of the reasonable structure of water conservancy investment of capital construction in China by AHP method. Water Resour Manag (forthcoming). doi:10.1007/s11269-008-9261-9

Copyright information

© Springer Science+Business Media B.V. 2008

Authors and Affiliations

  • Anastasios Michailidis
    • 1
  • Konstadinos Mattas
    • 1
  • Irene Tzouramani
    • 1
  • Diamantis Karamouzis
    • 1
  1. 1.Department of Agricultural EconomicsAristotle University of ThessalonikiThessalonikiGreece

Personalised recommendations