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Real Options Methodology In Public-Private Partnership Projects Valuation

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  • Biljana Rakic
  • Tamara Radenovic

Abstract

PPP offers numerous benefits to both public and private partners in delivery of infrastructure projects. However this partnership also involves great risks which have to be adequately managed and mitigated. Private partners are especially sensitive to revenue risk, since they are mostly interested in the financial viability of the project. Thus they often expect public partners to provide some kind of risk-sharing mechanism in the form of Minimum Revenue Guarantees or abandonment options. The objective of this paper is to investigate whether the real option of abandoning the project increases its value. Therefore the binominal option pricing model and risk-neutral probability approach have been implemented to price the European and American abandonment options for the Build-Operate-Transfer (BOT) toll road investment. The obtained results suggest that the project value with the American abandonment option is greater than with the European abandonment option, hence implying that American options offer greater flexibility and are more valuable for private partners.

Suggested Citation

  • Biljana Rakic & Tamara Radenovic, 2014. "Real Options Methodology In Public-Private Partnership Projects Valuation," Economic Annals, Faculty of Economics and Business, University of Belgrade, vol. 59(200), pages 91-114, January –.
    • Handle: RePEc:beo:journl:v:59:y:2014:i:200:p:91-114
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    References listed on IDEAS

    as
    1. Adam Borison, 2005. "Real Options Analysis: Where Are the Emperor's Clothes?," Journal of Applied Corporate Finance, Morgan Stanley, vol. 17(2), pages 17-31, March.
    2. Darrin Grimsey & Mervyn K. Lewis, 2005. "Are Public Private Partnerships value for money?," Accounting Forum, Taylor & Francis Journals, vol. 29(4), pages 345-378, December.
    3. David Ford & Diane Lander & John Voyer, 2002. "A real options approach to valuing strategic flexibility in uncertain construction projects," Construction Management and Economics, Taylor & Francis Journals, vol. 20(4), pages 343-351.
    4. Michael Garvin & Charles Cheah, 2004. "Valuation techniques for infrastructure investment decisions," Construction Management and Economics, Taylor & Francis Journals, vol. 22(4), pages 373-383.
    5. Yu-Lin Huang & Shih-Pei Chou, 2006. "Valuation of the minimum revenue guarantee and the option to abandon in BOT infrastructure projects," Construction Management and Economics, Taylor & Francis Journals, vol. 24(4), pages 379-389.
    6. Lawrence, Craig & Thomas, Mathew, 2008. "Real Options: Applications in Public Economics," MPRA Paper 11915, University Library of Munich, Germany.
    7. S. Ping Ho & Liang Liu, 2002. "An option pricing-based model for evaluating the financial viability of privatized infrastructure projects," Construction Management and Economics, Taylor & Francis Journals, vol. 20(2), pages 143-156.
    8. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
    9. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
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    Cited by:

    1. Loncar, Dragan & Milovanovic, Ivan & Rakic, Biljana & Radjenovic, Tamara, 2017. "Compound real options valuation of renewable energy projects: The case of a wind farm in Serbia," Renewable and Sustainable Energy Reviews, Elsevier, vol. 75(C), pages 354-367.

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    More about this item

    Keywords

    public-private partnership projects; real options; abandonment option;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • H44 - Public Economics - - Publicly Provided Goods - - - Publicly Provided Goods: Mixed Markets
    • H54 - Public Economics - - National Government Expenditures and Related Policies - - - Infrastructures

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