TY - JOUR
T1 - It's not now or never
T2 - implications of investment timing and risk aversion on climate adaptation to extreme events
AU - Truong, Chi
AU - Trück, Stefan
PY - 2016/9/16
Y1 - 2016/9/16
N2 - Public investment into risk reduction infrastructure plays an important role in facilitating adaptation to climate impacted hazards and natural disasters. In this paper, we provide an economic framework to incorporate investment timing and insurance market risk preferences when evaluating projects related to reducing climate impacted risks. The model is applied to a case study of bushfire risk management. We find that optimal timing of the investment may increase the net present value (NPV) of an adaptation project for various levels of risk aversion. Assuming risk neutrality, while the market is risk averse, is found to result in an unnecessary delay of the investment into risk reduction projects. The optimal waiting time is shorter when the insurance market is more risk averse or when a more serious scenario for climatic change is assumed. A higher investment cost or a higher discount rate will increase the optimal waiting time. We also find that a stochastic discount rate results in higher NPVs of the project than a discount rate that is assumed fixed at the long run average level.
AB - Public investment into risk reduction infrastructure plays an important role in facilitating adaptation to climate impacted hazards and natural disasters. In this paper, we provide an economic framework to incorporate investment timing and insurance market risk preferences when evaluating projects related to reducing climate impacted risks. The model is applied to a case study of bushfire risk management. We find that optimal timing of the investment may increase the net present value (NPV) of an adaptation project for various levels of risk aversion. Assuming risk neutrality, while the market is risk averse, is found to result in an unnecessary delay of the investment into risk reduction projects. The optimal waiting time is shorter when the insurance market is more risk averse or when a more serious scenario for climatic change is assumed. A higher investment cost or a higher discount rate will increase the optimal waiting time. We also find that a stochastic discount rate results in higher NPVs of the project than a discount rate that is assumed fixed at the long run average level.
KW - Climate change adaptation
KW - Investment timing
KW - Catastrophic risk
KW - Risk aversion
KW - Real option
UR - http://www.scopus.com/inward/record.url?scp=84959901999&partnerID=8YFLogxK
U2 - 10.1016/j.ejor.2016.01.044
DO - 10.1016/j.ejor.2016.01.044
M3 - Article
AN - SCOPUS:84959901999
SN - 0377-2217
VL - 253
SP - 856
EP - 868
JO - European Journal of Operational Research
JF - European Journal of Operational Research
IS - 3
ER -