THE VALUE OF FLEXIBILITY IN ADAPTING TO CLIMATE CHANGE: A REAL OPTIONS ANALYSIS OF INVESTMENTS IN COASTAL DEFENSE

Adaptation to climate change is likely to be a significant challenge for developing countries. We examine whether a real options approach that recognizes uncertainty and maintains future flexibility can provide an improved adaptation investment strategy. We use a Monte Carlo model to test four strategies for defending against sea level rise. Two of the strategies are inflexible, with the coastal defense fully specified in the first year of analysis. The other two strategies are flexible real options that allow adjustments in the coastal defense over time. We emphatically show that a real options strategy has the potential to increase the benefits of proactive adaptation. Our results prove to be location-dependent, underscoring the need for location-specific analysis. We find that the quality of the information obtained over time has an important bearing on option value and that a country's institutional capability and the specific mechanisms of international development assistance may affect implementation.