An Option Approach to Public Infrastructure Investment

27 Pages Posted: 11 Mar 2016 Last revised: 6 Apr 2021

Date Written: June 21, 2016

Abstract

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

Hendrickson, Joshua R., An Option Approach to Public Infrastructure Investment (June 21, 2016). Available at SSRN: https://ssrn.com/abstract=2746673 or http://dx.doi.org/10.2139/ssrn.2746673

Joshua R. Hendrickson (Contact Author)

University of Mississippi ( email )

Oxford, MS 38677
United States

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