Real Options–Based Approach for Valuation of Government Guarantees in Public–Private Partnerships
Publication: Journal of Infrastructure Systems
Volume 19, Issue 2
Abstract
A fast and computationally efficient valuation tool assists governments involved in Public–Private Partnership (P3) projects to examine many contractual configurations and design a guarantee that minimizes cost and reasonably mitigates the risk. This paper presents a continuous stochastic process derived from the risk factor forecast, thereby providing a more realistic and flexible model. A new valuation approach is developed by using a finite-difference method based on this continuous stochastic process. In a numerical example with one risk factor, it is shown that this new valuation tool is 100 times faster than the existing simulation-based approach. Its superior speed presents the opportunity to examine different contractual configurations, and as a result, design a more cost effective guarantee contract. Exercise strategies are derived for a multiple-exercise (Australian) guarantees structure. This new approach can be used by a government to reserve budget for the guarantees. Finally, the continuous underlying random process and exercise strategy enable this method to value more complex guarantee structures.
Get full access to this article
View all available purchase options and get full access to this article.
References
Brandao, L. E. T., and Saraiva, E. (2008). “The option value of government guarantees in infrastructure projects.” J. Constr. Manage. Econ., 26(11), 1171–1180.
Carverhill, A. (1994). “When is the short rate Markovian?” J. Math. Finance., 4(4), 305–312.
Cheah, C. Y. J., and Liu, J. (2006). “Valuing governmental support in infrastructure projects as real options using Monte Carlo simulation.” J. Constr. Manage. Econ., 24(5), 545–554.
Chiara, N. (2006). “Real option methods for improving economic risk management in infrastructure project finance.” Ph.D. thesis, Graduate School of Arts and Sciences, Columbia Univ., New York.
Chiara, N., and Garvin, M. (2008). “Variance models for project financial risk analysis with applications to Greenfield BOT highway project.” J. Constr. Manage. Econ., 26(9), 925–939.
Chiara, N., Garvin, M., and Vecer, J. (2007). “Valuing simple multiple-exercise real option in infrastructure projects.” J. Infrastruct. Syst., 13(2), 97–104.
Cui, Q., Johnson, P., Quick, A., and Hastak, M. (2008). “Valuing the warranty ceiling clause on New Mexico Highway 44 using a binomial lattice model.” J. Constr. Eng. Manage., 134(1), 10–17.
Dailami, M., and Klein, M. (1997). “Government support to private infrastructure projects in emerging markets.”, World Bank, Washington, DC.
Dailami, M., Lipkovich, I., and Van Dyck, J. (1999). “INFRISK: A computer simulation approach to risk management in infrastructure project finance transactions.”, World Bank, Washington, DC.
Duffy, D. J. (2006). Finite difference methods in financial engineering: A partial differential equation approach, Wiley, Chichester, West Sussex, UK.
Garvin, M., and Cheah, C. (2004). “Valuation techniques for infrastructure investment decisions.” J. Constr. Manage. Econ., 22(4), 373–383.
Glasserman, P. (2004). Monte Carlo methods in financial engineering, Springer, New York.
Glasserman, P., and Zhao, X. (1999). “Fast Greeks by simulation in forward LIBOR models.” J. Comput. Finance, 3(1), 5–39.
Ho, S. P., and Liu, L. Y. (2002). “An option pricing-based model for evaluating the financial viability of privatized infrastructure projects.” J. Constr. Manage. Econ., 20(2), 143–156.
Huang, Y. L., and Chou, S. P. (2006). “Valuation of the minimum revenue guarantee and option to abandon in BOT infrastructure projects.” J. Constr. Manage. Econ., 24(4), 379–389.
Hull, J. (2006). Options, futures, and other derivatives, 6th Ed., Prentice Hall, Upper Saddle River, NJ.
Irwin, T. (2003). “Public money for private infrastructure.”, World Bank, Washington, DC.
Martini, C. A., and Lee, D. Q. (1996). “Difficulties in infrastructure financing.” J. Appl. Finance Investment, 1(1), 24–27.
Ng, A., and Loosemore, M. (2007). “Risk allocation in the private provision of public infrastructure.” Int. J. Proj. Manage., 25(1), 66–76.
Ross, S. M. (2004). Introduction to probability and statistics for engineers and scientists, 3rd Ed., Elsevier Academic, Burlington, MA.
Threadgold, A. (1996). “Private financing of infrastructure and other longterm capital projects.” J. Appl. Finance Investment, 1(1), 7–12.
Wilmott, P. (2006). Paul Wilmott on quantitative finance, 2nd Ed., Wiley, Chichester, West Sussex, UK.
Zhao, T., Sundararajan, S. K., and Tseng, C. L. (2004). “Highway development decision-making under uncertainty: A real options approach.” J. Infrastruct. Syst., 10(1), 23–32.
Information & Authors
Information
Published In
Journal of Infrastructure Systems
Volume 19 • Issue 2 • June 2013
Pages: 196 - 204
Copyright
© 2013 American Society of Civil Engineers.
History
Received: Sep 19, 2011
Accepted: Jun 5, 2012
Published online: Aug 15, 2012
Published in print: Jun 1, 2013
Authors
Metrics & Citations
Metrics
Citations
Download citation
If you have the appropriate software installed, you can download article citation data to the citation manager of your choice. Simply select your manager software from the list below and click Download.