On the Real Option Value of Scientific Uncertainty for Public Policies

In this paper scientific uncertainty is defined as the impossibility to choose the correct stochastic process for the value of a public policy. The real option value of waiting under scientific uncertainty is derived using the difference between the geometric Brownian motion and the mean reverting process by applying contingent claim analysis. The results are compared with those generated by either using a geometric Brownian motion or a mean-reverting process only. The results show that scientific uncertainty is less important than one would expect at first hand. The small effect of scientific uncertainty adds confidence to the use of a geometric Brownian motion for the kind of public policy decisions discussed in this paper. The paper contributes to the suggestion made by scientists to analyze the sensitivity public policy valuations, provides insights about the magnitude of error that can be made by choosing the wrong process, provides a solution to the problem and highlights the implication for public policy decision making.