Climate Change Adaptation and Real Option Evaluation

Abstract

This report illustrates the application of a (relatively) new method to guide decision making under high (and unknowable) levels of uncertainty. The approach allows for the identification of robust policy options that are economically beneficial under different scenarios and varying levels uncertainty. Option value techniques are commonly employed in the finance literature to identify investment decisions that are resilient across a spectrum of outcomes. The methods are technically advanced and conceptually complex but they can be applied with ease with the wide availability of specialized software. The results of a pilot exercise conducted in Campeche suggest that even though global estimates for many costs have been used (such as sea wall construction) the magnitudes are so large that the results seem to be robust and are unlikely to alter dramatically with more refined data. In general options that are modular, build capacity and flexibility are found to lead to more robust and prudent adaptation options. It also suggests that studies at this scale are best conducted ahead of project design – even at the programmatic level - to guide the identification of suitable adaptation approaches.