It's Not Now or Never: Implications of Investment Timing and Risk Aversion on Climate Adaptation to Extreme Events

Truong, C., Trück, S., 2016, It's not now or never: Implications of Investment Timing and Risk Aversion on Climate Adaptation to Extreme Events, European Journal of Operational Research, 256, 856-868

37 Pages Posted: 27 Dec 2016

See all articles by Chi Truong

Chi Truong

Macquarie University; Financial Research Network (FIRN); Macquarie University, Macquarie Business School

Stefan Trück

Macquarie University Sydney - Department of Applied Finance and Actuarial Studies; Financial Research Network (FIRN); Centre for International Finance and Regulation (CIFR); Macquarie University, Macquarie Business School

Date Written: January 15, 2016

Abstract

Public investment into risk reduction infrastructure plays an important role in facilitating adaptation to climate impacted hazards and natural disasters. In this paper, we provide an economic framework to incorporate investment timing and insurance market risk preferences when evaluating projects related to reducing climate impacted risks. The model is applied to a case study of bushfire risk management. We find that optimal timing of the investment may increase the net present value (NPV) of an adaptation project for various levels of risk aversion. Assuming risk neutrality, while the market is risk averse, is found to result in an unnecessary delay of the investment into risk reduction projects. The optimal waiting time is shorter when the insurance market is more risk averse or when a more serious scenario for climatic change is assumed. A higher investment cost or a higher discount rate will increase the optimal waiting time. We also find that a stochastic discount rate results in higher NPVs of the project than a discount rate that is assumed fixed at the long run average level.

Keywords: Climate change adaptation, Investment timing, Catastrophic risk, Risk aversion, Real option

Suggested Citation

Truong, Chi and Trueck, Stefan, It's Not Now or Never: Implications of Investment Timing and Risk Aversion on Climate Adaptation to Extreme Events (January 15, 2016). Truong, C., Trück, S., 2016, It's not now or never: Implications of Investment Timing and Risk Aversion on Climate Adaptation to Extreme Events, European Journal of Operational Research, 256, 856-868, Available at SSRN: https://ssrn.com/abstract=2889857

Chi Truong

Macquarie University ( email )

North Ryde
Sydney, New South Wales 2109
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Macquarie University, Macquarie Business School ( email )

New South Wales 2109
Australia

Stefan Trueck (Contact Author)

Macquarie University Sydney - Department of Applied Finance and Actuarial Studies ( email )

North Ryde
Sydney, New South Wales 2109
Australia
61298508483 (Phone)
61298508483 (Fax)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Centre for International Finance and Regulation (CIFR) ( email )

Level 7, UNSW CBD Campus
1 O'Connell Street
Sydney, NSW 2000
Australia

Macquarie University, Macquarie Business School ( email )

New South Wales 2109
Australia

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