Using Real Option Techniques in Appraisal to Value the Options Provided by Transport Networks.
A Cartea, A Meaney, C Riley, Oxera Consulting Ltd, UK; T Worsley, H Zamani, Department for Transport, UK
Transport networks provide value over and above user benefits by providing insurance against uncertain journey times and trip patterns. This paper examines whether this value can be captured using real option valuation techniques.
Those involved in transport modelling and appraisal are accustomed to assuming that users of transport networks choose between modes based on their relative generalised costs. Introducing a new mode, or enhancing an existing one changes this balance, and generates benefits, and it is the task of appraisal to seek to capture the expected value of these benefits.
However, in a world of uncertainty, the costs of using particular modes may vary, and in these circumstances the existence of modes provides value?even if users don?t expect to use them. For example, regular journeys can suffer from poor performance or unavailability of the preferred mode. At times of poor performance or unavailability, an alternative mode with a higher average generalised cost may be chosen if the generalised cost of the preferred mode rises above this level. By providing this option to the user of the preferred mode, the alternative mode is valued over and above its expected user benefits.
In addition, since journey patterns over time are uncertain, a regular user (eg, a commuter) of a mode values its operation outside of normal usage times (eg, at the weekends). Again, this option to the user has a value over and above expected user benefits.
Laird and Geurs presented a paper at the 2007 ETC, which summarised the evidence from around the world on option (and non-use) values associated with transport networks. Option values are provided by transport networks that offer alternative means of making a journey, or enable unexpected trip making. Non-use values reflect the importance to someone of transport services that they may never use. Both of these aspects were shown to be important in appraisal, with option and non-use values recommended in the paper representing 5-10% of the present value of benefits associated with a railway line reopening.
However, the evidence base available to the authors was limited?only six stated preference studies have been carried out to estimate transport option and/or non-use values, and of these only two distinguished between option and non-use values. Furthermore, the evidence base is mostly focused on the option and non-use values associated with bus or rail services, from the perspective of the household. So, options provided by roads, diversionary routes for rail freight, and taxi services for example, were not valued.
This paper examines the feasibility of using techniques developed to value financial and real options in transport appraisal. Financial options are derivative securities traded on financial markets, which give the bearer the right, but not the obligation to buy or sell an underlying asset at a point in the future. Real options (so called because they relate to ?real? situations or decisions, as opposed to financial assets) have become an important element of the economics of investment appraisal, and recognise the flexibility inherent in many assets, and the insurance this provides against uncertainty.
Just like real options, transport networks give users the right, but not the obligation to use them at some point in the future, at a given generalised cost. With data on the generalised costs of the two modes, and on the variability of generalised cost of the preferred mode, the value of the option provided by the alternative mode can be valued using real options techniques.
Similarly, since there is uncertainty about how often a user will need to travel, transport networks provide option value through enabling unexpected trip making. For leisure journeys, for example, there is a range of values of expected benefits associated with a particular destination, and with data on these values, and the generalised cost of the transport link to that destination, an option value can be generated using real options techniques.
This paper answers the following questions:
· What are the assumptions behind the valuation of financial options, and how are these altered for valuing real options?
· How well does this framework fit with the option and non-use values attributed to transport networks and can it be altered if necessary?
· Can the framework be applied to the case study in the Laird/Geurs paper?
· Are there further applications of this approach that provide insights across a wide range of transport contexts?
The paper will compare and contrast valuations obtained from the existing transport literature with indicative values from the financial/real options valuation approach, and will conclude with thoughts on the implications for appraisal.
Association for European Transport