Abstract
The uncertainty of forecasted runoffs brings risks of water shortages to water users in the intake area of long-distance water transfer projects, and the uncertainty of spot market prices may cause them to buy water at high prices. In order to hedge these risks, this paper proposes a risk hedging model for decision-making in water option trading from the viewpoint of water users. With the objective of maximizing the expected revenue of water users, the proposed model was solved by an analytical method and an optimal water option strategy was obtained for the users. The proposed model is applied to an intake area of an inter-basin water transfer project in China. The results show that the proposed water option trading model can provide water users with an optimal option strategy. The optimal options trading strategy can effectively reduce the risk caused by the uncertainties of forecasted runoffs and water prices. We also explored the influence of the uncertainty degree of the forecasted runoffs and water price on the option trading strategy. The results show that the expected revenue of water users increases as the variances of the errors of forecasted runoffs and water prices increase.
Highlights
To alleviate the regional water scarcity caused by climate change [1] and the uneven spatial and temporal distribution of water resources, many countries and regions have built long-distance water transfer projects
The optimal water purchase strategy for water users is to use the local water first, and water shortages will be overcome by a contract of transferred water [3]
In order to solve the risk of water shortages and buying water at high prices caused by the forecasted runoff error and the fluctuation of water price, this paper establishes a water option trading mode, and explores the influence of the water runoff uncertainty and the fluctuation of water price on the water option trading strategy
Summary
To alleviate the regional water scarcity caused by climate change [1] and the uneven spatial and temporal distribution of water resources, many countries and regions have built long-distance water transfer projects. The optimal water purchase strategy for water users is to use the local water first, and water shortages will be overcome by a contract of transferred water [3] This simple decision process becomes complex due to the uncertainty of local water runoffs [4,5] and the fluctuation of spot market prices. Based on the comparison of the expected cost of the option trading and the expected cost of the spot trading, this paper establishes a water option trading model to hedge water supply risks with the objective of maximizing the expected revenue of water users from their own perspective. It follows that 3 ofthe execution condition of water options is stricter than that of the ordinary financial options It is of great significance for the users to research the optimal water options trading strategies
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