Real Options Analysis for Flood Control Facilities Taking Account of Climate Change Uncertainty

Abstract

As global warming progresses, predictably the amount of rainfall and the frequency of heavy rainfall will increase. Therefore, it is necessary to develop flood control facilities to deal with the increase in rainfall. However, there is a great deal of uncertainty about how quickly climate change will progress and how much the temperature will rise. Thus, it is necessary to take into consideration every scenario related to future increase in rainfall so as to properly determine the timing of construction of flood control facilities. This study proposes a real options analysis (ROA) model to control the budget allocation for flood control facilities, considering the uncertainty of climate change, along with a heuristic solution method for it. Furthermore, we apply the proposed ROA model and solution method to a basin in Japan. The result confirms that the optimal solution of the ROA model significantly reduces the social cost compared to inflexible planning.