THE OPTION EFFECT OF ECONOMIC DEVELOPMENT IN NORTH CYPRUS

Abstract

Purpose: To explain the wide-spread under-investment in north Cyprus, especially infrastructure such as electricity and water supply. Methodology: Considering the real option effect in business investment under the conventional cost-benefit analysis. Findings: Due to the uncertain nature of north Cyprus' future geo-political status, any foreign investment must not only pass the conventional cost-benefit analysis, but also overcome a significant mark-up in net benefit before it can profitably go ahead. This is because potential investors could stand to lose a large amount of initial capital outlay if political situation were to deteriorate. The ability to avoid this has an intrinsic value (option value). This must be overcome by any profitable investment. Hence, the presence of wide-spread under-investment in the small-island economy. This is especially so in infrastructure such as electricity and water supply. Originality: A first attempt to explain the lack of investment in north Cyprus using real option analysis.