Using Real Options Theory to Enhance Highway Asset Intervention Scheduling

Nathee Athigakunagorn, Purdue University

Abstract

Highway agencies have a fiduciary responsibility for cost-effective upkeep of highway assets worth trillions of dollars. A critical aspect of this stewardship is the ability to make informed decisions regarding the scheduling of interventions geared to enhance infrastructure capacity and structural integrity or to maintain a state of good repair. Development of such schedules which are time-based or condition-based, often proceeds with the implicit assumption that a certain asset-related parameter of volatility will continue to follow a certain pattern on the basis of observed past trends. However, given the uncertain nature of the asset environment, it is often the case that the economic attractiveness of an investment determined at the analysis year may not be the same over time. In some cases, it is possible to scale back, defer, or expand the investment at a future time in order to avoid excessive losses or to capture additional rewards; in other cases, it is not easy to scale back, defer, or expand. As stewards of taxpayer money, highway agencies place great value on any flexibility they may be granted to exercise these options. Unfortunately, the traditional economic evaluation methods provide a means for capturing the value of such flexibility in decision-making. This dissertation addresses this issue by proposing a methodology to value the flexibility associated with their intervention scheduling using Real Options Analysis (ROA). ROA borrows the valuation method from finance literature and has been applied in a few contexts of transportation management. ROA for project evaluation makes it possible to determine a value of the flexibility to defer, abandon, or proceed with the investment, and more importantly, to use such valuation in the evaluation and decision process. The recommended decision is one that maximizes the project value not only in terms of the project outcomes but also in terms of the inherent flexibility available. In this dissertation’s proposed methodology, the first step identifies the parameter of volatility or the source of the uncertainty. The next step determines the project cost components for both the agency costs and user costs and establishes the discount rates and analysis period. The possible pathways for the parameter of volatility are established using a binomial lattice, and the final project value corresponding to each pathway is determined. The developed methodology establishes optimal intervention timing and scheduling, that is both time- and performance-based, thereby reaping the relative merits of both broad approaches. To demonstrate the application of the methodology, this dissertation presents four illustrative case studies: highway shoulder widening, travel lane expansion, optimal maintenance threshold determination, and optimal time for paving unpaved roads. The findings from the case studies confirm the advantages of using ROA over the traditional method and corroborate the efficacy of ROA as an effective method of economic evaluation that appropriately captures the value of flexibility.

Degree

Ph.D.

Advisors

Labi, Purdue University.

Subject Area

Civil engineering|Transportation planning

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