Private Investment in Biodiversity Conservation : a Real Option Approach

In the 1990’s, the World Agroforestry Centre (ICRAF) initiated a domestication programme of indigenous fruit trees (IFTs) in Southern Africa to increase farmhousehold income through farmer-led tree planting and thus conserve bio-diversity. From the farmer's point of view planting domesticated IFTs is an investment under uncertainty and irreversibility. As timing of planting is flexible, real options theory suggests that waiting to invest may be a profit maximising strategy. Applying the real option theory the critical value of an investment in planting IFTs is derived using contingent claim analysis. As previous studies on ex-ante assessments investments in agriculture have used dynamic optimisation, we use contingent claims and explicitly derive the risk adjusted rate of return from the Consumer Capital Asset Pricing Model by using the different sources of farm-household income. Our analysis investigates to what level (1) fruit collection cost and/or (2) the necessary technical change, i.e. breeding progress, have to rise that will render tree planting economical. Results show a combination of technical change and decrease in resource abundance provides scope for farmer-led planting of domesticated IFTs and bio-diversity conservation. However, breeding progress must be significant for investment in tree planting to be economically attractive and thus to contribute towards on-farm preservation of the IFTs.