A Bayesian Real Options Model for Adaptation to Catastrophic Risk under Climate Change Uncertainty
نویسندگان
چکیده
We present a novel framework for the valuation of investments to mitigate catastrophic risk of climate impacted hazards. Our model incorporates the impact of uncertainty and continuous Bayesian information updating on investment decisions. We show that the model is relevant even when the time required to resolve uncertainty is indefinite. The model is applied to bushfire risk management in a local area. Our findings suggest that investment based on the net present value (NPV) rule that ignores the value of the investment option results in significant losses. Sensitivity analysis results suggest that the loss is large when the investment cost is high, when the uncertainty resolution is slow, or when the probability belief in climate change is low.
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