UNDERSTANDING LAND IDLING AS A STRATEGIC BEHAVIOUR: A BRIEF NOTE USING THE REAL OPTIONS APPROACH

Abstract

One possible explanation for land idling in a rapidly transforming economy can be found by looking at the value of the option to wait and hysteresis behaviour in the land market. If investors assume that the drop is temporary and that its long term prospects outweigh current holding losses, the market will observe some form of a zone of inactivity i.e., no selling and no additional buying. The fact that landowners elect to keep their valuable land underdeveloped for prolonged periods of time suggests that idled land is more flexible and valuable than what the current market price suggests. If the revenue from farming is insufficient to sustain the activity, land is left idle; although this operational decision is open to continuous revision. The numerical example shown in the paper shows that price of land can be substantially bolstered by the option to wait embedded in land. We argue that land market prices are based on more than the land’s total present value of its future income stream. In a transforming economy, the option to wait and change land-use are especially important to consider. Policy-wise, the government can discourage land idling by ensuring appropriate and suitable zoning of agricultural areas, strong adherence to the zoning conditions/plans as well as more far-sighted land conversion decisions. These efforts can go a long way to reduce the source and degree of uncertainty which is the most important cause of real option premium in land prices. Based on the nature and type of data available, future directions of research should emphasize on empirical testing of real options premium in sale prices of agricultural land.