Real Option Analysis of Primary Rail Contracts in Grain Shipping

Abstract

Grain shipping for a country elevator involves many sources of risk and uncertainty. In response to these dynamic challenges faced by shippers, railroad carriers offer various types of forward contracting instruments and shuttle programs. Certain contracting instruments provide managerial flexibility by allowing shippers to sell excess railcars into a secondary market. The purpose of this study is to value this transferability as a European put option. A framework is developed around a material requirement planning schedule and real option analysis to represent the strategic decisions facing a primary shuttle contract owner. Monte Carlo simulation is incorporated with a stochastic binomial option pricing model to value the transfer option. A sensitivity analysis is then conducted to determine the impact of key input variables. This study provides insights about railcar ordering strategy, and the implications of transferable rail contracts for shippers and carriers.