Valuing Simple Multiple-Exercise Real Options in Infrastructure Projects

TLDR

Infrastructure projects such as build–operate–transfer face significant revenue risk. The study proposes a governmental revenue guarantee to secure a minimum revenue level for such projects. The guarantee is structured as a Bermudan or simple multiple‑exercise real option redeemable only at specific times, and its value is estimated using a multi‑least‑squares Monte Carlo method. This approach is more flexible than existing methods, enhancing risk mitigation and facilitating contractual and financial negotiations in BOT projects.

Abstract

The revenue risk is considerable in infrastructure project financing arrangements such as build–operate–transfer (BOT). A potential mitigation strategy for the revenue risk is a governmental revenue guarantee, where the government secures a minimum amount of revenue for a project. Such a guarantee is: (1) only redeemable at distinct points in time; and (2) more economical if the government limits the guarantee's availability to the early portions of a BOT's concession period. Hence, a guarantee characterized by this type of structure takes the form of either a Bermudan or a simple multiple-exercise real option, depending upon the number of exercise opportunities afforded. The multi-least-squares Monte Carlo technique is presented and illustrated as a promising approach to determine the fair value of this variety of real option. This method is far more flexible than prevailing approaches, so it represents an important step toward improving risk mitigation and facilitating contractual and financial negotiations in BOT projects.