A real options model for the financial valuation of infrastructure systems under uncertainty

Build-Operate-Transfer (BOT) is a form of Public-Private Partnerships that is commonly used to close the growing gap between the cost of developing and modernizing transportation infrastructure systems and the financial resources available to governments. When assessing the feasibility of a BOT project, private investors consider revenue risk - which is stemmed from the uncertainty about future traffic demand - as a critical factor. A potential approach to mitigating the revenue risk is the offering of revenue risk sharing mechanisms such as Minimum Revenue Guarantee options by the government. In addition to Minimum Revenue Guarantee options, a mechanism known as Traffic Revenue Cap options may also be negotiated, which makes the government entitled to a share of revenue when it grows beyond a specified threshold. Financial valuation of investments in BOT projects should take into account uncertainty about future traffic demand, as well as Minimum Revenue Guarantee and Traffic Revenue Cap options. The conventional valuation methods including Net Present Value (NPV) analysis are not capable of integrating the uncertainty about future traffic demand in the valuation of BOT projects and properly pricing Minimum Revenue Guarantee and Traffic Revenue Cap options. Real options analysis can be used as an alternative approach to valuation of investments in transportation projects under uncertainties. However, the appropriate application of real options analysis to valuation of investments in transportation projects is conditioned upon overcoming specific theoretical challenges. Current real options models do not provide a systematic method for estimating the project volatility, which measures the variability of investment value. Existing models do not provide a method for calculating the market value of Minimum Revenue Guarantee and Traffic Revenue Cap options. Also, current models are not able to characterize the impact of Minimum Revenue Guarantee and Traffic Revenue Cap options on private investors' financial risk profile. The overarching objective of this research is to apply the real options theory in order to price Minimum Revenue Guarantee and Traffic Revenue Cap options under the uncertainty about future traffic demand. To achieve this objective, a real options model is created that characterizes the long-term traffic demand uncertainty in BOT projects and determines investors' financial risk profile under uncertainty about future traffic demand. This model presents a novel method for estimating the project volatility for real options analysis. This model devises a market-based option pricing approach to determine the correct value of Minimum Revenue Guarantee and Traffic Revenue Cap options. An appropriate procedure is created for characterizing the impact of Minimum Revenue Guarantee and Traffic Revenue Cap options on the investors' financial risk profile. The proposed real options model is applied to a BOT project to illustrate the valuation process. The limitations of the proposed real options model, as well as the barriers to its implementation, are identified and recommendations for future research are offered. This research contributes to the state of knowledge by presenting a new method for estimating the project volatility, which is required for the real options analysis of transportation investments. It also introduces a risk-neutral valuation method for pricing the market value of Minimum Revenue Guarantee and Traffic Revenue Cap options in BOT projects. The research also contributes to the state of practice by introducing a novel class of assessment tools for decision makers that characterize the investors' financial risk profile under uncertainty about future traffic demand. Proper methods for pricing of Minimum Revenue Guarantee and Traffic Revenue Cap options are useful to public and private investors, in order to avoid wasting capital in transportation projects.PhDCommittee Chair: Baabak Ashuri; Committee Member: Adjo A. Amekudzi; Committee Member: Daniel Castro-Lacouture; Committee Member: Darryl VanMeter; Committee Member: Kathy O. Roper; Committee Member: Keith R. Molenaa