Real Options Analysis for Smart Grid: The Role of Information Technology and Public Policy

Abstract

Smart cities depend on smart grid for resilient energy delivery and improved energy efficiencies. This paper employs the real option approach (ROA) to study the investment decision of information technology innovation in the case of smart grid adoption under uncertainty. We argue that investing in smart grid is analogous to having the option rights in a financial (American) call option. We propose a model taking the smart grid cost as primary decision variable to identify the optimal first time to adopt smart grid. We conclude that unless government provide sufficient financial support, certain projects would not be economically feasible. The study illustrated the use of ROA an important tool for simulate the impact of public policy on the adoption of the smart grid technology, and provided policy recommendations.

Keywords: Smart grid, information technology, real options theory, investment under uncertainty, public policy