Managing risks from climate impacted hazards - The value of investment flexibility under uncertainty

Chi Truong, Stefan Trück, Supriya Mathew

    Research output: Contribution to journalArticlepeer-review

    Abstract

    Incomplete knowledge about climate change and the related uncertainty in climate prediction makes adaptation inherently difficult. We introduce a real options framework to determine the optimal adaptation to catastrophic risk that takes into account climate change uncertainty. The framework can be used to select the optimal adaptation project from a number of alternative projects or to determine the optimal investment sequence of the considered projects. In applying the model to the management of bushfire risk at a local government area, we find that the framework can significantly increase the value of adaptation investment, above the current net present value, and also improve upon deterministic dynamic models. We also find that it is important to consider sequential investment to preserve investment flexibility under the uncertainty of climate change. When decision makers can afford multiple investment projects, the loss associated with the use of a simple net present value rule can be substantial, and it is important to use a deterministic dynamic model or a real options model.

    Original languageEnglish
    Pages (from-to)132-145
    Number of pages14
    JournalEuropean Journal of Operational Research
    Volume269
    Issue number1
    DOIs
    Publication statusPublished - 16 Aug 2018

    Fingerprint

    Dive into the research topics of 'Managing risks from climate impacted hazards - The value of investment flexibility under uncertainty'. Together they form a unique fingerprint.

    Cite this