Revenue Risk Allocation Mechanism in Public-Private Partnership Projects: Swing Option Approach

A fair revenue-risk allocation is essential for successful public-private partnership (PPP) projects. In this paper, a swing option, which can hedge the underlying risk in two directions above and below expectations, is introduced to model a revenue risk allocation contract in PPP projects. In the contract, a minimum revenue guarantee (MRG) and excess revenue sharing (ERS) are integrated. The contract is fair for the public and private partners in that it covers and balances the MRG and ERS. Moreover, the contract embeds the incentive and flexibility by granting the concessionaire swing rights. The contract is priced using a least-squares Monte Carlo simulation. Through a demonstration case of a highway in China, the contract values for different allocation parameters are obtained, providing a reference for negotiations between the government and the concessionaire; the optimal strategies for exercising the swing rights are also presented, according to which the concessionaire can decide when to exert the swing rights. The new revenue risk allocation mechanism developed by the swing option method could enrich the revenue risk allocation theory of PPP projects.

Automated summary

This paper introduces a new swing option method to model revenue risk allocation contracts in PPP projects, integrating minimum revenue guarantees and excess revenue sharing while embedding incentives and flexibility through granting swing rights. Through a demonstration case of a highway in China, contract values for different allocation parameters are obtained, providing a reference for negotiations and optimal strategies for exercising swing rights. The new revenue risk allocation mechanism developed by the swing option method enriches the theory of revenue risk allocation in PPP projects.