Smart Agriculture
and Real Options
PASQUALE LUCIO SCANDIZZO
THE UNIVERSITY OF ROME «TOR VERGATA»
Key findings about real options

A real option (RO) is defined as the faculty, but not the obligation, to
undertake an action for an expected benefit at a given cost.

The (RO) methods are a series of techniques based on the RO notion
and of contingent decision making.

RO techniques complement and enhance business management,
project evaluation and generally decision making, by using more
information in a «smarter» way.

More recently, RO techniques have become the basis of new
«smart» methods of production, aimed not only to evaluate existing
ROs, but also to design projects and plans with more ROs built into
them.
Real Options for Adaptability

Planning adaptation to the unknown is challenging,
given the many uncertainties relating to climate change
scenarios and socio-economic pathways.

Smart agriculture is based on the dual notion of
diversification and flexibility, a complementary pair
based on the concept of real options.
The Real Options Strategy allows for analyzing
adaptability and related build up of capabilities rather
than being limited to estimating the cost/benefit ratio of
adaptation projects.

Diversification and Real Options
A different conception of the production process
as a series of contingent actions.
 Depending on the state of the world:
 Activities as options to deliver different inputs
(e.g. soil and nutrient management, harvesting
genetic resources);
 Outputs as options to generate different
outcomes (e.g. early or late crops, harvesting,
processing and supply chains).

Real Options and Smart
Adaptation Principles
First, practice no regrets management: preserve and value
the potential of a diversified environment.
Second, when considering a given investment for
adoption, carefully consider “the option to wait” by
comparing net expected benefits with investment costs,
multiplied by a “hurdle rate. This is a multiple of the
investment cost whose size depends on uncertainty.
Third , use the capability/real options strategy to invest in
adaptability rather than in mere adaptation.
Flexibility and Real Options for
Climate Change

Climate change (CC) as an opportunity to create real options:

(i) coping options that address the damage caused by
transitory adverse events;

(ii) rebound options that concern actions to recover and gain
strength from negative developments/events;

(iii) opportunity options that are related to taking advantage
of opportunities caused by climate change; and

(iv) adaptation options designed for permanent changes in
response to CC.
Results from a recent World Bank
Study:Yemen (US$ per household)
Hurdle Rate
Options created
Underlying
Value
(present value
of increase in
Value Added
per farm)
Estimates of
strike prices
(present
value of
investment)
Volatility
range
Value of
Option
Coping option: changes of
practices in response to
climate change
13150
8110
0.10 - 0.39
6570
2.0- 3.67
20570
12690
0.33- 0.7
12480
3.5- 5.31
Agricultural research,
extension, post harvesting
equipment, community
infrastructure for marketing
and transportation
Rebound option: terrace
rehabilitation
Opportunity option: high
value crops (coffee, fruits
and vegetables)
13530
8350
0.10 - 0.33
7190
Education, training,
information programs on
climate change patterns
and possible responses
Long term adaptation
option: education (4 years)
30750
18970
0.10 - 0.3
13740
Investment in human and
non human capital that
created the options
Training, extension,
recovering knowledge on
traditional techniques
Terrace building, barrier
construction, contour
sloping, land improvements
2- 3.35
2- 3.18
Results from a recent World Bank Study:
Morocco (US$ per household)
Investment in human and
non human capital that
created the options
Training, extension,
recovering knowledge on
traditional techniques
Terrace building, barrier
construction, contour
sloping, land improvements
Options created
Opportunity Option:
Planting fruit trees
Underlying
Value
(present value
of increase in
Value Added
per farm)
Estimates of
strike prices
(present
value of
investment)
Hurdle Rate
Volatility
range
Value of
Option
3,5- 5,6
7080
3680
0.35 - 0.75
4300
3.5- 5.6
Agricultural research,
extension, post harvesting
equipment, community
infrastructure for marketing
and transportation
Rebound/ Opportunity
Option:
Local financial systems
Credit extension
12200
6340
0.33- 0.75
7409
Results from a recent World Bank Study:
Tunisia (000 US$ per household)
Threats from climate
change:
Rise in temperature,
increase in the variance
of rainfall Floods,
landslides and droughts,
Landscape loss,
landslides, soil
degradation
Alteration of the forest
ecosystem, loss of
biodiversity, loss of the
ecological services
provided, such as local
climate stabilization, a
rebound option for
animals and plants in
case of extreme events,
the preservation of a
stable soil structure.
Investment in human and
non human capital
creating the option
Options created
Training, extension,
recovering knowledge on
traditional techniques
Research,
National park
management
Research, Extension,
Plantation
Forest pasture and rage
improvements
Coping options: Forest
management, watershed
and landscape
management (increase in
non use value), reduction
of forest fires
Underlying
Value
(Present value
of increase in
Value Added
per ha)
Estimates of
strike prices
(present value
of investment)
Range of
Option Values
corresponding
to values of
Volatility
between 30%
and 70%
22 – 29
50
40
Opportunity options:
Improving life conditions,
Improving forest
production and
competitiveness
Rebound options:
Preserving biodiversity,
preventing erosion and
other environmental
degradation
134.50
57 -76
120.5
31.66
46 – 51
76
Conclusions : Real Options and
Empowerment

Real options provide a means to address uncertainty of climate
change through “smart agriculture” by focusing on the capabilities
created by investment.

Projects that create more valuable options are thus to be preferred
to projects that create fewer options or destroy some of the options
available, even though, for some limited time and within some
scenarios, the latter may seem to be preferable on the traditional
grounds of expected net present value.

Because creating capabilities is a “bottom up “ approach, it entails
a form of empowerment by endowing people with valuable real
options that they can use under alternative scenarios.