Impact of irreversibility and uncertainty on the timing of infrastructure projects

This paper argues that because of the irreversibility and uncertainty associated with Build - Operate - Transfer (BOT) infrastructure projects, their financial evaluation should also routinely include the determination of the value of the option to defer the construction start-up. This ensures that project viability is comprehensively assessed before any revenue or loan guarantees are considered by project sponsors to support the project. This paper shows that the framework can be used even in the context of the intuitive binomial lattice model. This requires estimating volatility directly from the evolution of the net operating income while accounting for the correlation between the revenue and costs functions. This approach ensures that the uncertainties usually associated with toll revenues, in particular, are thoroughly investigated and their impact on project viability is thoroughly assessed. This paper illustrates the usefulness of the framework with data from an actual (BOT) toll road project. The results show that by postponing the project for a couple of years the project turns out to be viable, whereas it was not without the deferral. The evaluation approach proposed therefore provides a better framework for determining when and the extent of government financial support, if any, that may be needed to support a BOT project on the basis of project economics. The analysis may also be applicable to private sector investment projects, which are characterized by irreversibility and a high rate of uncertainty

The History of the Quantitative Methods in Finance Conference Series. 1992-2007

This report charts the history of the Quantitative Methods in Finance (QMF) conference from its beginning in 1993 to the 15th conference in 2007. It lists alphabetically the 1037 speakers who presented at all 15 conferences and the titles of their papers.

Interest rate models with Markov chains

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On the market consistent valuation of fish farms: using the real option approach and salmon futures

We consider the optimal harvesting problem for a fish farmer in a model which accounts for stochastic prices featuring Schwartz (1997) two factor price dynamics. Unlike any other literature in this context, we take account of the existence of a newly established market in salmon futures, which determines risk premia and other relevant variables, that influence risk averse fish farmers in their harvesting decision. We consider the cases of single and infinite rotations. The value function of the harvesting problem determined in our arbitrage free setup constitutes the fair values of lease and ownership of the fish farm when correctly accounting for price risk. The data set used for this analysis contains a large set of futures contracts with different maturities traded at the Fish Pool market between 12/06/2006 and 22/03/2012. We assess the optimal strategy, harvesting time and value against two alternative setups. The first alternative involves simple strategies which lack managerial flexibility, the second alternative allows for managerial flexibility and risk aversion as modeled by a constant relative risk aversion utility function, but without access to the salmon futures market. In both cases, the loss in project value can be very significant, and in the second case is only negligible for extremely low levels of risk aversion. In consequence, for a risk averse fish farmer, the presence of a salmon futures market as well as managerial flexibility are highly important

An Analysis of the Heston Stochastic Volatility Model: Implementation and Calibration using Matlab

This paper analyses the implementation and calibration of the Heston Stochastic Volatility Model. We first explain how characteristic functions can be used to estimate option prices. Then we consider the implementation of the Heston model, showing that relatively simple solutions can lead to fast and accurate vanilla option prices. We also perform several calibration tests, using both local and global optimization. Our analyses show that straightforward setups deliver good calibration results. All calculations are carried out in Matlab and numerical examples are included in the paper to facilitate the understanding of mathematical concepts.Comment: 34 page

A market-consistent framework for the fair evaluation of insurance contracts under Solvency II

The entry into force of the Solvency II regulatory regime is pushing insurance companies in engaging into market consistence evaluation of their balance sheet, mainly with reference to financial options and guarantees embedded in life with-profit funds. The robustness of these valuations is crucial for insurance companies in order to produce sound estimates and good risk management strategies, in particular, for liability-driven products such as with-profit saving and pension funds. This paper introduces a Monte Carlo simulation approach for evaluation of insurance assets and liabilities, which is more suitable for risk management of liability-driven products than common approaches generally adopted by insurance companies, in particular, with respect to the assessment of valuation risk