Investment decision making in a deregulated electric industry using stochastic dominance

Abstract

This article focuses on investment on capacity expansion in a deregulated electric industry, under conditions of uncertainty. Particularly, it describes a framework for the application of the concepts of stochastic dominance to the investment decision making process. The Chilean electricity market case is taken as a general framework. After briefly describing its main characteristics, it is discussed how to obtain the probability distribution of the net present value (NPV) of an investment in a new generating plant, using a long term planning model. Having the NPV distribution, and information about investors' risk attitude, stochastic dominance concepts can be applied to complement the investment decision making process. The most interesting aspect regarding the methodology discussed is that it takes into consideration the whole distribution of returns from an investment, not relying just on the expected NPV, or a particular measure of risk. Nevertheless, stochastic dominance produces only a partial ordering of investment alternatives.