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Über dieses Buch

This book sets out to reframe the theory of real options so that it can be used to support environmental investments for climate change adaptation and mitigation. Climate change policy often involves making decisions that concern extended time periods, and doing so under considerable uncertainty. By expanding and broadening the framework of real options, this book first introduces readers to new ways of quantifying investment decisions that can much more effectively address the shape and size of the uncertainty than traditional approaches using Net Present Value. In turn, the second part of the book applies this new theoretical framework to climate change policy by presenting a number of examples, and by providing a general perspective on investment decisions related to climate change and how to prioritize them.

Inhaltsverzeichnis

Frontmatter

Chapter 1. Prolegomena: What Does Real Option Analysis Bring to Climate Change Policy

Abstract
The word prolegomena is defined as “a critical or discursive introduction to a book.” This is what it means here but with a twist. The German philosopher Immanuel Kant (1724–1804) wrote Prolegomena zu einer jeden künftigen Metaphysik, die als Wissenschaft wird auftreten können, or Prolegomena to Any Future Metaphysics That Will Be Able to Present Itself as a Science. In that book, Kant in a rather polemic way explained what he wanted to accomplish by writing a previous book, Critique of Pure Reason, which many think is his masterpiece but was poorly received at the time.
Benoit Morel

Chapter 2. Toward a General Theory of Real Options

Abstract
This chapter reviews history of financial option from its origin with Bachelier and continuing with the contributions of Black–Scholes and Merton. The origin of the concept of real option (S. Myers) is also discussed. The relation (conceptual and mathematical) between financial and real option, as well as the concept of risk neutrality and its relevance for real options, is discussed ad nauseam. In the process, a mathematical framework for real option analysis (ROA) is developed. This chapter is somewhat math-intensive. Of particular importance for the rest of the book are the discussions of first-degree homogeneity and risk neutrality and their mathematical implications.
Without the Black–Scholes formula, ROA would probably not exist. It was Black–Scholes who inspired Stewart Myers to introduce the concept of real options in his study of the value of a firm. He emphasized the importance of growth options in the valuation of a firm, and he called those options “real options.” As a result, not only does ROA have its roots in the culture of corporate investments, but it also grew in that cobweb. The downside is that ROA is seen as a mere extension of financial options, when in fact it should be the opposite: financial options being the particularization to the world of finance of a broader concept, real options. When it comes to climate change policy, this distinction is fundamental, because it is what makes ROA applicable there.
Benoit Morel

Chapter 3. Real Option Analysis: Work in Progress, in Need of Progress

Abstract
This chapter is openly polemical. This book would not exist if real options analysis (ROA) had progressed the way other fields of knowledge do. It did not. That has everything to do with the stifling impact of Black-Scholes on ROA. The modern form of financial option theory started around 1973 with Black-Scholes. The concept of real option was introduced soon afterward in 1977. After all these years, ROA is nowhere as developed as financial option theory. The difference of degree of advancement between the two is so huge that it begs to be explained. This is the theme of this chapter.
Benoit Morel

Chapter 4. Extreme Events, Cat Bonds, ROA in the Context of Fat Tail Distributions, and the Weitzman Effect

Abstract
In this chapter the mathematical framework developed in Chap. 2 is used to apply ROA in an area for which extensions of Black-Scholes or NPV cannot be used: fat tail distributions, i.e., areas in distributions where extreme events reside. This chapter paves the way to the policy discussion of the response to climate change, where such distributions are pervasive.
Benoit Morel

Chapter 5. Global CO2 Emission Mitigation Through the Looking Glass of ROA

Abstract
Except for a few loonies, most agree that there is an imperative not to let the atmospheric load of CO2 grow indefinitely. “Doing nothing implies that risks are negligible. That position implies an absurd degree of certainty” [Wolf, Financial Times (27 Oct 2015)]. As some like to say, there is no planet B. The economics of climate change is far, far behind its science. Given the important role of uncertainty in climate change policy and the debilitating limitations of alternatives such as NPV or the “neoclassical” approach, i.e., the “integrated assessment models,” when it comes to uncertainty, the detour of ROA is unavoidable. The interface between ROA and climate change turns out to be rather explosive and reveals how deep the need for a response to climate change goes.
Benoit Morel

Chapter 6. Internationalization of the Response: The Example of the REDD Credits

Abstract
One can read in Chap. 11 of the WGIII AR5 IPCC report that REDD credits (REDD is for Reduced Emissions from Deforestation and Forest Degradation) “can represent a cost-effective option for mitigation with economic, social, and other environmental co-benefits, e.g., conservation of biodiversity and water resources” with the caveat that there is limited evidence for that and only medium agreement. In this chapter, using the ROA looking glass, we investigate some aspect of how to make REDD credits cost-effective and compare with what actually happens. Despite the apparent difference, there is more similarity between what the ROA approach would recommend and what takes place.
Benoit Morel

Chapter 7. Prioritizing the Investments Needed to Avoid the Unmanageable (Mitigation) and to Manage the Unavoidable (Adaptation)

Abstract
According to the present “scientific evidence,” the “unmanageable” is part of our possible futures. Mitigation of CO2 emissions is an imperative. There are many sources of emissions of greenhouse gases (GHGs), and however global the mitigation effort may be, it has a strong local component. The rest of the world has a vested interest in mitigation efforts everywhere. It is a case of “act locally but think globally.” Mitigation involves also transitioning to a greener economy. Adaptation, on the other hand, is the purview of individual countries. Their needs and situations differ widely. Most countries have an adaptive capacity gap, including the USA (Preston et al. 2011). That was eloquently illustrated by the devastation that Hurricane Katrina brought to New Orleans in August 2005. Still, the gap is as a rule more pronounced in poor countries, which are also the least equipped to fill it. Furthermore, adaptation intersects with other concerns: “Climate change adds to the list of stressors that challenge our ability to achieve the ecologic, economic and social objectives that define sustainable development” (IPCC 2007).
This chapter discusses the interface between real option analysis (ROA) and the response to climate change in general terms. The interface is rather complex and involves quite a few moving parts. In this chapter those issues are discussed in general. A more pedestrian introduction to how to operationalize ROA in the context climate change investments can be found in Appendix B.
Benoit Morel

Chapter 8. Unanswered Questions About Uncertainty, Information, and Investment Decisions

Abstract
Books far too often come with answers only. They convey a warm feeling that everything is under control. This book is not in that tradition. Hopefully, it will inspire some to realize that the frontier of knowledge in ROA is only work in progress and at an early stage of progress. Unanswered questions are the prerequisites to change, progress, and even sometime scientific revolutions. This book is an invitation for those who think that ROA can make a difference to help making it go to the next level.
Benoit Morel

Backmatter

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