Real Options in Infrastructure: Revisiting the Literature

Abstract

Infrastructure networks are essential to support the world’s economic development. Governments around the world, in both developed and developing economies, have dedicated significant shares of the public budget to infrastructure development and refurbishment. Nevertheless, there has been an increasing concern about the selection of economically more interesting projects. The large sunk investments, as well as the uncertainty surrounding these projects, require new and more sophisticated investment analysis techniques. Simultaneously, there has been a recent trend towards increasing the flexibility in these projects to allow a more progressive adaptation to changing market conditions, thus decreasing the overall risk affecting these investments. The flexibility is introduced through real options that include the possibility of change that one develops in the planning and design stage, allowing the infrastructure (and service) to cope with future uncertainty. This paper intends to provide an overview of the current literature on real options, thereby fulfilling a gap in current academic literature. It addresses the main types of options and valuation mechanisms and provides an extensive overview of their application to the infrastructure sector.