What is Making Investment in the Texas Vineyard Industry Tick? A Real Options Analysis of Entry and Exit

The Texas wine industry of the United States has experienced substantial growth in recent years and yet is constrained by a significant lack of supply of Texas grown grapes. Using a real options framework we examine the role that wine grape price uncertainty plays on the financial decision to invest in vineyard operations in the state of Texas. Given reasonable estimates of required rates of returns, investment and operating costs for typical Texas vineyards, it is found that grape price uncertainty results in a delay in investment and subsequently a lack of grape supply. This delay in investment, known as hysteresis, is often found in situations involving large fixed investments combined with uncertain returns. In general the results indicate that average prices for Texas grapes would have to increase by 30 to 40 percent in order for a significant expansion in Texas vineyards to take place. (JEL Classification: Q120, Q140, G310, D920)