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Real Options: Applications in Public Economics


  • Lawrence, Craig
  • Thomas, Mathew


This paper illustrates the use of real options principles to value prototypical resource and industryinvestment projects. It captures important competitive/strategic dimensions in a step-by-stepanalysis of investment decisions (options) under uncertainty. It compares and contrasts staticdiscounted cash flow analysis (DCF) with real options analysis using three case studies. The initialexample values a resource extraction process using static DCF and then compares the projectvaluation when future information is valued and acted upon. The second example considers a coaldevelopment and uses the binomial valuation approach to capture the option value associated withhaving the right but not the obligation to exit the development. It contrasts this valuation approachagainst static DCF and highlights that future royalty payments could be underestimated if based onthe standard DCF valuation. The third example analyses the impact of providing a subsidy forhybrid vehicle production to accelerate potential uncertain environmental benefits. Lastly, thesuitability of the standard financial and economic evaluation tools used by treasury agencies isconsidered when projects contain real options.

Suggested Citation

  • Lawrence, Craig & Thomas, Mathew, 2008. "Real Options: Applications in Public Economics," MPRA Paper 11915, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:11915

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    References listed on IDEAS

    1. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-157, April.
    2. Krüger, Niclas A. & Svensson, Mikael, 2009. "The impact of real options on willingness to pay for mortality risk reductions," Journal of Health Economics, Elsevier, vol. 28(3), pages 563-569, May.
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    Cited by:

    1. Biljana Rakic & Tamara Radenovic, 2014. "Real Options Methodology In Public-Private Partnership Projects Valuation," Economic Annals, Faculty of Economics, University of Belgrade, vol. 59(200), pages 91-114, January –.

    More about this item


    financial economics; investment decisions; public economics; externalities; subsidies; project evaluation;

    JEL classification:

    • H10 - Public Economics - - Structure and Scope of Government - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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