Investing in adaptation: Flood risk and real option application to Bilbao

Investment decisions in adaptation are usually made under significant uncertainty due to climate change and socio-economic trends. In this study, we propose three ways to incorporate climate and socioeconomic uncertainty into the assessment of an adaptation infrastructure designed to cope with floodrisk in the city of Bilbao. First, we use stochastic modelling to estimate the present value of expected damage over a time period, considering that extreme events may increase in the future. Second, we develop an additional calculation that incorporates two risk measures used in financial economics: Value-at-Risk and Expected Shortfall, the latter being a less common but better risk indicator. Third, we illustrate a case of Real Options Analysis (ROA) in which a binomial tree is used to study whether the best decision at present is to invest now or to delay the investment decision. (C) 2017 Elsevier Ltd. All rights reserved.