Validation of SD Models for the Valuation of Exotic Options in Infrastructure Investment

Abstract

There has been a significant amount of research related to the valuation of real options that are increasingly complex in terms of payoff structure. In addition, infrastructure procurement is becoming more complex as individual assets are increasingly viewed as being part of a larger network of interdependent systems. In response, this investigation utilizes a System Dynamics (SD) model to capture the relationships between competing assets where simulation results elucidate the causal effects between multiple investments that traverse infrastructure systems. An illustrative case study includes an SD model that simulates historical real-world relationships between water treatment alternatives within the shale gas value chain. This research contributes to the existing body of knowledge by showing how SD models can be used to value multiple types of real options within a portfolio of competing infrastructure assets. The valuation of each investment must consider the value of an underlying asset as well as the compounding effects of competing alternatives. Although this case study is based on water treatment options in the shale gas industry, the same methodology can be used to value real options found in other infrastructure systems.