Abstract
Decisions on long-lived flood risk management (FRM) investments are complex because the future is uncertain. Flexibility and robustness can be used to deal with future uncertainty. Real options analysis (ROA) provides a welfare-economics framework to design and evaluate robust and flexible FRM strategies under risk or uncertainty. Although its potential benefits are large, ROA is hardly used in todays' FRM practice. In this paper, we investigate benefits and limitations of a ROA, by applying it to a realistic FRM case study for an entire river branch. We illustrate how ROA identifies optimal short-term investments and values future options. We develop robust dike investment strategies and value the flexibility offered by additional room for the river measures. We benchmark the results of ROA against those of a standard cost-benefit analysis and show ROA's potential policy implications. The ROA for a realistic case requires a high level of geographical detail, a large ensemble of scenarios, and the inclusion of stakeholders' preferences. We found several limitations of applying the ROA. It is complex. In particular, relevant sources of uncertainty need to be recognized, quantified, integrated, and discretized in scenarios, requiring subjective choices and expert judgment. Decision trees have to be generated and stakeholders' preferences have to be translated into decision rules. On basis of this study, we give general recommendations to use high discharge scenarios for the design of measures with high fixed costs and few alternatives. Lower scenarios may be used when alternatives offer future flexibility.
| Original language | English |
|---|---|
| Pages (from-to) | 3018-3036 |
| Number of pages | 19 |
| Journal | Water Resources Research |
| Volume | 54 |
| Issue number | 4 |
| Early online date | 24 Mar 2018 |
| DOIs | |
| Publication status | Published - Apr 2018 |
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Keywords
- adaptation
- cost-benefit analysis
- Delta Programme
- flood risk management
- real options analysis
- room for the river
Cite this
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Benefits and Limitations of Real Options Analysis for the Practice of River Flood Risk Management. / Kind, Jarl M.; Baayen, Jorn H.; Botzen, W. J.Wouter.
In: Water Resources Research, Vol. 54, No. 4, 04.2018, p. 3018-3036.Research output: Contribution to Journal › Article › Academic › peer-review
TY - JOUR
T1 - Benefits and Limitations of Real Options Analysis for the Practice of River Flood Risk Management
AU - Kind, Jarl M.
AU - Baayen, Jorn H.
AU - Botzen, W. J.Wouter
PY - 2018/4
Y1 - 2018/4
N2 - Decisions on long-lived flood risk management (FRM) investments are complex because the future is uncertain. Flexibility and robustness can be used to deal with future uncertainty. Real options analysis (ROA) provides a welfare-economics framework to design and evaluate robust and flexible FRM strategies under risk or uncertainty. Although its potential benefits are large, ROA is hardly used in todays' FRM practice. In this paper, we investigate benefits and limitations of a ROA, by applying it to a realistic FRM case study for an entire river branch. We illustrate how ROA identifies optimal short-term investments and values future options. We develop robust dike investment strategies and value the flexibility offered by additional room for the river measures. We benchmark the results of ROA against those of a standard cost-benefit analysis and show ROA's potential policy implications. The ROA for a realistic case requires a high level of geographical detail, a large ensemble of scenarios, and the inclusion of stakeholders' preferences. We found several limitations of applying the ROA. It is complex. In particular, relevant sources of uncertainty need to be recognized, quantified, integrated, and discretized in scenarios, requiring subjective choices and expert judgment. Decision trees have to be generated and stakeholders' preferences have to be translated into decision rules. On basis of this study, we give general recommendations to use high discharge scenarios for the design of measures with high fixed costs and few alternatives. Lower scenarios may be used when alternatives offer future flexibility.
AB - Decisions on long-lived flood risk management (FRM) investments are complex because the future is uncertain. Flexibility and robustness can be used to deal with future uncertainty. Real options analysis (ROA) provides a welfare-economics framework to design and evaluate robust and flexible FRM strategies under risk or uncertainty. Although its potential benefits are large, ROA is hardly used in todays' FRM practice. In this paper, we investigate benefits and limitations of a ROA, by applying it to a realistic FRM case study for an entire river branch. We illustrate how ROA identifies optimal short-term investments and values future options. We develop robust dike investment strategies and value the flexibility offered by additional room for the river measures. We benchmark the results of ROA against those of a standard cost-benefit analysis and show ROA's potential policy implications. The ROA for a realistic case requires a high level of geographical detail, a large ensemble of scenarios, and the inclusion of stakeholders' preferences. We found several limitations of applying the ROA. It is complex. In particular, relevant sources of uncertainty need to be recognized, quantified, integrated, and discretized in scenarios, requiring subjective choices and expert judgment. Decision trees have to be generated and stakeholders' preferences have to be translated into decision rules. On basis of this study, we give general recommendations to use high discharge scenarios for the design of measures with high fixed costs and few alternatives. Lower scenarios may be used when alternatives offer future flexibility.
KW - adaptation
KW - cost-benefit analysis
KW - Delta Programme
KW - flood risk management
KW - real options analysis
KW - room for the river
UR - http://www.scopus.com/inward/record.url?scp=85048001663&partnerID=8YFLogxK
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U2 - 10.1002/2017WR022402
DO - 10.1002/2017WR022402
M3 - Article
VL - 54
SP - 3018
EP - 3036
JO - Water Resources Research
JF - Water Resources Research
SN - 0043-1397
IS - 4
ER -