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RESEARCH ARTICLE
Contents Vol 58(10)

Adapting to climate change and managing climate risks by using real options

Greg Hertzler
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School of Agricultural and Resource Economics, The University of Western Australia, 35 Stirling Highway, Crawley, WA 6009, Australia. Email: Greg.Hertzler@uwa.edu.au

Australian Journal of Agricultural Research 58(10) 985-992 https://doi.org/10.1071/AR06192
Submitted: 14 June 2006  Accepted: 4 October 2007   Published: 30 October 2007

Abstract

Adapting to climate change and managing climate risks are new challenges for farmers, community leaders, and catchment management authorities. To meet this challenge, a new method of making decisions under risk may help. This method is called real options. It begins with common sense and adds rigour. It helps us decide when to keep our options open and when to foreclose options and create new ones. In this paper, real options are explained and applied to several examples by developing a new type of decision diagram. The diagrams are a language for thinking about complex decisions under risk. Farmers, community leaders, and catchment management authorities can develop similar diagrams and use them to communicate with other decision makers and with researchers. Finally, the decision diagrams are related to new mathematical tools to help find optimal decisions for managing climate risks.

Additional keywords: decision trees, stochastic dynamic programming, option pricing, weather derivatives, index insurance.


Acknowledgments

This research is supported by the project ‘Enabling NRM Decision Makers to Make Better Use of Climate Science’, Land and Water Australia (Reference No. SRD7). Some of the information in this paper was presented at the World Meteorological Organisation Expert Team Meeting on the Impact of Climate Change/Variability on Medium- to Long-Range Predictions for Agriculture, 15–18 February 2005, Brisbane. I also thank an anonymous reviewer for the decision tree in Fig. 3 and for comments which helped to clarifying the decision diagrams.


References


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