An option pricing-based model for evaluating the financial viability of privatized infrastructure projects

Ho, S. Ping; Liu, Liang Y.

doi:10.1080/01446190110110533

Cited by 126 publications

(56 citation statements)

References 20 publications

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“…The …rst is that on the real-option approach, which has been applied in several areas, but has not been extensively used to address procurement topics. The available works mostly focus on the evaluation, from a contractor's perspective, of a project embedding some elements of managerial ‡exibility (see, for example, Ford et al, 2002;Ho and Liu, 2002;Garvin and Cheah, 2004), without addressing the e¤ects of ‡exibility on agents' bidding behaviour. One of the few exceptions is the paper by You and Tam (2006) who, however, do not employ a game-theoretic framework to analyse how managerial discretion in ‡uences 3 Resolution 78(3) adopted by the Committee of Ministers on January 20, 1978.…”

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confidence: 99%

Procurement with Unenforceable Contract Time and the Law of Liquidated Damages

Dosi

Moretto

2013

Journal of Law, Economics, and Organization

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Time overruns are common in public works and are not con…ned to inherently complex tasks. One explanation advanced in this paper is that bidders can undergo unpredictable changes in production costs which generate an option value of waiting. By exploiting the real-option approach, we examine how the inability to force sellers to meet the contract time in ‡uences their bidding behaviour, and how this can ultimately a¤ect the parties' expected payo¤s. Further, we examine the outcome of the bidding process when legal rules prevent the promisee from contracting for damage measures which would grant more than her lost expectation. We show that when the pre-agreed compensatory payments prove insu¢ cient to discourage delayed orders, setting a liquidated damages clause would not lead to a Pareto superior outcome with respect to the no-damage-for delay condition. While such a clause would increase the seller's expected payo¤, the buyer's expected payo¤ is lower than when the contract does not provide for any compensation for late-delivery.

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confidence: 99%

Procurement with Unenforceable Contract Time and the Law of Liquidated Damages

Dosi

Moretto

2013

Journal of Law, Economics, and Organization

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“…To the best of our knowledge, the only research piece based on a two-factor uncertainty model, in the context of BOT projects, where the stochastic variables are the present value of the cash-flows and the construction costs is the paper by Ho and Liu (2002). In fact, these researchers considered the construction costs and the present value of cash-flows as being both stochastic variables, behaving according to Geometric Brownian Motions.…”

Section: Two-factor Uncertainty Models In the Real Options Literaturementioning

confidence: 99%

“…Public-Private Partnerships (PPP) became one of the most important types of public procurement arrangements and its importance has been growing considerably in the last decades (Kwak et al (2009); Alonso-Conde et al (2007); Algarni et al (2007); Ho and Liu (2002)). PPP is usually defined as a long-term development and service contract between the government and a private partner (Maskin and Tirole (2008)).…”

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confidence: 99%

“…PPP is usually defined as a long-term development and service contract between the government and a private partner (Maskin and Tirole (2008)). This type of contract may assume different forms and the Build-Own-Transfer (BOT) model is widely adopted (Liu and Cheah (2009) ;Ho and Liu (2002)). BOT is the terminology for a project structure that uses private investment to undertake the infrastructure development, and which has been historically ensured by the public sector.…”

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confidence: 99%

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A Two-Factor Uncertainty Model to Determine the Optimal Contractual Penalty for a Build-Own-Transfer Project

2013

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Public-Private Partnerships (PPP) became one of the most common types of public procurement arrangements and Build-Own-Transfer (BOT) projects, awarded through adequate bidding competitions, have been increasingly promoted by governments. The theoretical model herein proposed is based on a contractual framework where the government grants leeway to the private entity regarding the timing for project implementation. However, the government is aware that delaying the beginning of operations will lead to the emergence of social costs, i.e., the costs that result from the corresponding loss of social welfare. This fact should motivate the government to include a contractual penalty in case the private firm does not implement the project immediately. The government also recognizes that the private entity is more efficient in constructing the project facility. The model's outcome is the optimal value for the legal penalty the government should include in the contract form. A two-factor uncertainty approach is adopted and Adkins and Paxson (2011) quasi-analytical solution is applied since homogeneity of degree one can not be invoked in all of the model's boundary conditions. Sensitivity analysis reveals that variations in the correlation coefficients have a strong impact on the optimal contractual penalty and also that there is a level for the comparative efficiency factor above which there is no need to impose a contractual penalty, for a given level of social costs. Finally, the effects of including a non-optimal penalty value in the contract form, which derives from overestimating or underestimating the selected bidder's real comparative efficiency are examined, using a numerical example. Results demonstrate that overestimating (underestimating) the selected bidder's real comparative efficiency leads to the inclusion of a below-optimal (above-optimal) value for the legal penalty in the contract and produces effects that the government would prefer to prevent. JEL Classification Codes: G31; D81.

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“…Wooldridge et al (2002) evaluated the flexibility in toll road project considering the option pricing theory with a case of Dulles Greenway. Other works include Ho and Liu (2002) who adopted the option pricing approach to the value against equity in a BOT project by formulating a discrete-time model to reflect the stochastic processes of project value and construction cost under the condition of debt guarantee and negotiation option.…”

Section: Applying Option Pricing Theory Into Infrastructure Projectsmentioning

confidence: 99%

Appraisal of Combined Agreements in Bot Project Finance: Focused on Minimum Revenue Guarantee and Revenue Cap Agreements

Jun

2010

International Journal of Strategic Property Management

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ABSTRACT. Limited public funds for infrastructures have the government consider joining the private in a BOT project finance scheme. Generally, the BOT projects entail lots of managerial flexibilities that may induce the radical change of project's cash flows, an asymmetric payoff, when facing on the uncertainties due to the BOT project finance's unique characteristics. Among various managerial flexibilities in the BOT projects, the MRG (Minimum Revenue Guarantee) and the RCP (Revenue Cap) agreements are frequently used to protect the government and the developer from the operational risk. However, the combined effect of the MRG and RCP on the project value is not understood well because the traditional capital budgeting theory, the NPV (Net Present Value) analysis, is limited to assess the contingency of these agreements. So, the purpose of this paper is to develop the numerical model to assess the combined impact of the MRG and RCP agreements on the project value based on the option pricing theory and to suggest a theoretical framework. The approach applied in this paper is justified with the hypothetical BOT toll case and some meaningful conclusions are drawn from. The results by the option pricing concept are analyzed over those by NPV analysis and, finally, the combined value of the MRG and RCP agreements appears significant relative to the project value.

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An option pricing-based model for evaluating the financial viability of privatized infrastructure projects

Cited by 126 publications

References 20 publications

Procurement with Unenforceable Contract Time and the Law of Liquidated Damages

Procurement with Unenforceable Contract Time and the Law of Liquidated Damages

A Two-Factor Uncertainty Model to Determine the Optimal Contractual Penalty for a Build-Own-Transfer Project

Appraisal of Combined Agreements in Bot Project Finance: Focused on Minimum Revenue Guarantee and Revenue Cap Agreements

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