The Use of Real Option Approach for the Evaluation of Climate Investments

Luis Mari Abadie and Ibon Galarraga

Chapter 14 in Climate Finance:Theory and Practice, 2017, pp 335-359 from World Scientific Publishing Co. Pte. Ltd.

Abstract: Climate finance refers to flows of resources or funds for activities related to combating climate change, i.e., reducing greenhouse gases (GHGs) emissions or adapting to climate change. This definition can cover many types of investment, and indeed their number is increasing in the fields of both mitigation and adaptation. Such investments entail numerous uncertainties and therefore risks, which can sometimes be reduced. In many cases, uncertainties persist to a large extent as regards to future cash flows. These investments can be assessed using financial methods that take their specific aspects into account, i.e., considering the stochastic behavior of significant variables such as the price of emission allowances, electricity prices in the case of renewables, fossil fuel prices if the project involves replacing or reducing the output of such fuels, sea level rise (SLR) in some adaptation cases, temperature increases, the risk of default on projects, exchange rate risks, uncertainty in the cost of investment and other case-specific factors.Firms that invest in projects of this type clearly expect returns in proportion to the risks that they run.This chapter uses a number of examples to demonstrate the application of techniques developed in the field of finance to valuing investments classified as climate finance. The chapter specifically deals with real option (RO) approach. This approach is tailored specifically to valuing irreversible investments under conditions of uncertainty and can include the case of projects with risk of default.The examples here use market quotes for the variables included in the analysis whenever such information is available.The results show that it is important to factor uncertainty into the valuation of almost all types of investment, but especially so in the case of climate finance investment.

Keywords: Climate Finance; Adaptation; Mitigation; Green Climate Fund; International Environmental Agreements; International Transfers; Economics (search for similar items in EconPapers)
Date: 2017
References: Add references at CitEc
Citations:

Downloads: (external link)
https://www.worldscientific.com/doi/pdf/10.1142/9789814641814_0014 (application/pdf)
https://www.worldscientific.com/doi/abs/10.1142/9789814641814_0014 (text/html)
Ebook Access is available upon purchase.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wsi:wschap:9789814641814_0014

Ordering information: This item can be ordered from

Access Statistics for this chapter

More chapters in World Scientific Book Chapters from World Scientific Publishing Co. Pte. Ltd.
Bibliographic data for series maintained by Tai Tone Lim ().