An Option Approach to Public Infrastructure Investment
19 Pages Posted: 11 Mar 2016 Last revised: 30 Jun 2016
Date Written: June 21, 2016
How do we ensure that public infrastructure is properly and adequately maintained and replaced? How can we ensure that the allocation of infrastructure spending is not motivated by the political process? In this paper, I present an option value approach that offers an answer to both questions and I argue that this approach is superior to the current net present value approach (NPV). This yields several important results. First, I show that the NPV approach is not sufficient. Second, the option value approach allows for an explicit valuation for comparisons between projects. Third, the option approach provides an explicit formula for managing a transportation fund for infrastructure projects. Finally, the option value approach provides the means for a rule-of-law for managing infrastructure projects that ensures that both needed investment takes place and that funding is not allocated based on political value.
Keywords: real options, public infrastructure
JEL Classification: H54
Suggested Citation: Suggested Citation