Real options model of toll adjustment mechanism in concession contracts of infrastructure projects

xiv, 217 leaves : ill. ; 30 cm.PolyU Library Call No.: [THS] LG51 .H577P BRE 2013 ChenEffective management of demand risk is of great significance for the private investor participating in a concession contract of infrastructure project, such as the traffic risk in a BOT toll road project. To attract private participation in such capital intensive projects characterized by huge sunk cost, a variety of uncertainties and risks, long-term financing agreements (usually spanning over several decades), and non-recourse/limited-recourse project financing scheme, the host government often has to provide risk mitigation mechanisms, among which traffic/revenue guarantees have been widely applied around the world in numerous projects. The contractual and managerial flexibility embedded in such arrangements can be deemed as real options; therefore real options theory has been adopted by scholars and practitioners to value the project. However, guarantees (in essence contingent liabilities for the host government) may bring heavy fiscal burdens to the host government if the actual traffic is much more pessimistic than the projected level, which is not rarely seen in economic recessions. Toll Adjustment Mechanism (TAM), a hybrid of price cap regulation mechanism and revenue sharing mechanism, is one solution to prevent the private investor from severe traffic demand risk and the government from heavy fiscal burden, at the same time to ensure the private investor a reasonable but not excessive rate of return. Nevertheless, Toll Adjustment Mechanism (TAM) has not been investigated as broadly and in-depth as guarantees; quantitative modelling and analysis of TAM is even much scarcer. Therefore this research intends to fill this gap by modelling TAM as real options, developing a framework to assess the value of flexibility of the right (but not obligation) of toll adjustments. First, a stochastic traffic demand model is developed; second, a traffic assignment (two-route choice) model is built to quantify the demand function of the toll and the traffic on the toll road, therefore the optimal pricing strategies in each period during the concession period can be obtained; then the optimal pricing strategy in multi periods, with the objective of maximizing the net present value (NPV) of the project, can be obtained through real options analysis. A hypothetical case study derived from a real life project, Western Harbour Crossing in Hong Kong, is illustrated in detail to demonstrate the application of the framework developed and to validate the effectiveness and robustness of the framework. Outcomes of the research can help the government to design reasonable concession contracts and help the private investors to make sound investment decisions through effective management of the traffic demand risk. Therefore a win-win prospect can be achieved in public-private-partnering concession contracts for both parties.Department of Building and Real EstatePh.D., Dept. of Building and Real Estate, The Hong Kong Polytechnic University, 201