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Title:

A Real Option Approach for Financial Valuation of Material Price Adjustment Clauses in Transportation Projects

Accession Number:

01590724

Record Type:

Component

Abstract:

Volatility in material costs has been a serious challenge for state Departments of Transportation (DOTs) and contractors since the last decade. Volatility and uncertainty in the price of critical materials increases the risk of contractors in fixed-price contracts and can lead to price speculation and bid inflation. One of the most common strategies used to address inflated bid prices and encourage the submission of lower bids is price adjustment clauses (PACs) which guarantee an adjustment in payments to contractors based on the size and direction of material price changes. Contrary to the widespread application of PACs by state DOTs, there is little knowledge about the financial value of offering PACs in transportation contracts. This gap in knowledge makes it difficult for contractors and state DOTs to systematically evaluate the impacts of offering PACs on their risk profiles. The research objective of this paper is to develop a model that measures the financial value of PACs in transportation contracts. In this study, the authors apply real option theory to price the PACs in transportation projects. A market-based option pricing approach called risk-neutral valuation method is devised to determine the financial value of the PACs. The results of this study will enable state DOTs and contractors to develop their economic risk profiles and more precisely handle the risk of material price volatility.

Supplemental Notes:

This paper was sponsored by TRB committee AFH10 Standing Committee on Construction Management.

Monograph Accession #:

01584066

Report/Paper Numbers:

16-5862

Language:

English

Corporate Authors:

Transportation Research Board

500 Fifth Street, NW
Washington, DC 20001 United States

Authors:

Ilbeigi, Mohammad
Ashuri, Baabak
Kashani, Hamed

Pagination:

13p

Publication Date:

2016

Conference:

Transportation Research Board 95th Annual Meeting

Location: Washington DC, United States
Date: 2016-1-10 to 2016-1-14
Sponsors: Transportation Research Board

Media Type:

Digital/other

Features:

Figures; References

Subject Areas:

Administration and Management; Construction; Highways; I10: Economics and Administration; I50: Construction and Supervision of Construction

Source Data:

Transportation Research Board Annual Meeting 2016 Paper #16-5862

Files:

TRIS, TRB, ATRI

Created Date:

Jan 12 2016 6:35PM