BC3 Journal Article “Investing in adaptation: flood risk and real option application to Bilbao”

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Abadie, L.M., Sainz de Murieta, E.,Galarraga, I. 2017. Investing in adaptation: flood risk and real option application to Bilbao. Environmental Modelling & Software. 95. 76-89. DOI (10.1016/j.envsoft.2017.03.038)

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Investment decisions in adaptation are usually made under significant uncertainty due to climate change and socio-economic trends. In this study, we propose three ways to incorporate climate and socio-economic uncertainty into the assessment of an adaptation infrastructure designed to cope with flood-risk in the city of Bilbao. First, we use stochastic modelling to estimate the present value of expected damage over a time period, considering that extreme events may increase in the future. Second, we develop an additional calculation that incorporates two risk measures used in financial economics: Value-at-Risk and Expected Shortfall, the latter being a less common but better risk indicator. Third, we illustrate a case of Real Options Analysis (ROA) in which a binomial tree is used to study whether the best decision at present is to invest now or to delay the investment decision.

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