Infrastructure Investment Under Uncertainty: Reconciling Private and Public Incentives

75 Pages Posted: 17 Jul 2020

See all articles by Maria Lavrutich

Maria Lavrutich

Norwegian University of Science and Technology

Verena Hagspiel

Norwegian University of Science and Technology (NTNU) - Department of Industrial Economics and Technology

Afzal Siddiqui

Stockholm University - Department of Computer and Systems Sciences; Aalto University - Department of Mathematics and Systems Analysis

Date Written: June 25, 2020

Abstract

Private companies (PCs) in restructured infrastructure industries, e.g., energy and transportation, determine facility investment timing and sizing. Such decisions maximize the PC's expected profit (rather than social welfare) under uncertainty. By anticipating the PC's incentives, a welfare-maximizing transmission system operator (TSO) shapes the network to align public and private objectives. Via an option-based approach, we first quantify welfare losses from the PC's and TSO's conflicting objectives. We show that by anticipating the optimal decisions of the profit-maximizing PC, the TSO is able to reduce welfare loss. In this setting, however, the TSO is still not able to enforce the social optimum under substantial market volatility. Next, we exploit the dependence of the PC's capacity on the TSO's infrastructure design to devise a proactive transmission-investment strategy. Hence, we mitigate welfare losses arising from misaligned incentives even in relatively uncertain markets.

Keywords: Investment under uncertainty, transmission planning, capacity choice

JEL Classification: D81, G31, L13, L97

Suggested Citation

Lavrutich, Maria and Hagspiel, Verena and Siddiqui, Afzal, Infrastructure Investment Under Uncertainty: Reconciling Private and Public Incentives (June 25, 2020). Available at SSRN: https://ssrn.com/abstract=3635409 or http://dx.doi.org/10.2139/ssrn.3635409

Maria Lavrutich (Contact Author)

Norwegian University of Science and Technology ( email )

NO-7491 Trondheim
Norway

Verena Hagspiel

Norwegian University of Science and Technology (NTNU) - Department of Industrial Economics and Technology ( email )

NO-7491 Trondheim
Norway

Afzal Siddiqui

Stockholm University - Department of Computer and Systems Sciences ( email )

Stockholm
Sweden
164 07 (Fax)

Aalto University - Department of Mathematics and Systems Analysis ( email )

P.O. Box 11100
Helsinki, 00076
Finland

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