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We develop a real option model of the irreversible native grassland conversion decision. Upon plowing, native grassland can be followed by either a permanent cropping system or a system in which land is put under cropping (respectively, grazing) whenever crop prices are high (respectively, low). Switching costs are incurred upon alternating between cropping and grazing. The effects of risk intervention in the form of crop insurance subsidies are studied, as are the effects of cropping innovations that reduce switching costs. We calibrate the model by using cropping return data for South Central North Dakota from 1989 to 2012. Simulations show that a risk intervention that offsets 20% of a cropping return shortfall increases the sod-busting cost threshold, below which native sod will be busted, by 41% (or $43.7/acre). Omitting cropping return risk across time underestimates this sod-busting cost threshold by 23% (or $24.35/acre), and hence underestimates the native sod conversion caused by crop production.

Keywords: conservation tillage ; crop insurance policy ; irreversibility ; native grassland ; sodbusting.

Subject(s): Environmental Economics and Policy

Risk and Uncertainty

Issue Date: 2013-02

Publication Type: Working or Discussion Paper

PURL Identifier:

Total Pages: 45

Series Statement: CARD Working Paper

13-WP 536

Record appears in: Iowa State University > Center for Agricultural and Rural Development (CARD) > CARD Working Paper Series

Autor: Miao, Ruiqing ; Hennessy, David A. ; Feng, Hongli


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