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Option value

Summary:
Like most of us, I’m not expert on epidemiology. But I have spent most of my life studying risk management. In the current crisis, one of the most relevant issue,s and the one that policymakers seem to be ignoring is that of option value. To see what’s involved, consider a policy choice like shutting down bars and cinemas, as opposed to waiting two weeks to see what happens. If, in two weeks time, it turns out the virus has been contained, the ban can be reversed and the loss is that of the two week shutdown,. On the other hand, if the virus spreads through contact in these venues, there is no way of limiting the damage to two weeks. Nearly all the time, this reasoning favors aggressive early action. The exceptions are actions like cancelling events scheduled some months in the

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Like most of us, I’m not expert on epidemiology. But I have spent most of my life studying risk management. In the current crisis, one of the most relevant issue,s and the one that policymakers seem to be ignoring is that of option value. To see what’s involved, consider a policy choice like shutting down bars and cinemas, as opposed to waiting two weeks to see what happens. If, in two weeks time, it turns out the virus has been contained, the ban can be reversed and the loss is that of the two week shutdown,. On the other hand, if the virus spreads through contact in these venues, there is no way of limiting the damage to two weeks.

Nearly all the time, this reasoning favors aggressive early action. The exceptions are actions like cancelling events scheduled some months in the future. Deferring the decision would increase losses in the event of a cancellation, but keep open the option of going ahead if the situation improved.

Sadly, there seems to be no sign that those in charge of the policy response understand this. Rather, the reasoning seems to be to wait until they are sure a risk-reduction measure is necessary before implementing it. That is a recipe for avoidable disaster.

John Quiggin
He is an Australian economist, a Professor and an Australian Research Council Laureate Fellow at the University of Queensland, and a former member of the Board of the Climate Change Authority of the Australian Government.

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