Abstract

This paper applies option-pricing theory to evaluate an investment decision by farmers regarding their potential conversion to organic agriculture. Because the adoption of organic-farming techniques involves risk and uncertainty, there is a need for well-designed policy schemes (including possible incentives and subsidies for farmers). However, conventional accounting methods for analysis of such investment decisions-such as the commonly used net present value (NPV) method-have limitations under uncertain economic conditions. This study demonstrates that the framework of real-options analysis is an appropriate form of analysis to examine the question of investment profitability under risk and uncertainty, and to assess the role of economic subsidies in policies designed to encourage organic farming.