Abstract
Many sewage treatment facilities in China have been developed and operated using the Public-Private Partnerships (PPP) model. However, a big challenge faced by these PPP projects is that the subsidy requested from the government during the operation is normally higher than what was estimated originally, thus often exceeding the budget that the government can afford. This leads to a high risk of project failure or insufficient operation. This problem is largely caused by the uncertainties exhibited in the existing models, such as the Black-Scholes (BS) model. While being used in the budget estimation, these models cannot sufficiently account for the short-term uncertainty that may be incurred during the operation of projects. In this study, a method to account for this short-term uncertainty has been proposed to improve the BS model. This allows for investigations to address issues related to how the real option value of a government subsidy is affected. A Monte Carlo simulation was performed to take into account the noise in the estimation. A sensitivity analysis further revealed that this discrepancy is largely affected by the values of the relevant parameters in the short-term uncertainty model. We found that the short-term uncertainty has a significant effect on private revenue and government subsidy and that the changes of the latter are more sensitive to the change of short-term uncertainty. The value of the relevant variables of short-term uncertainty determined the fluctuation of the revenue. The mean value and revenue had a positive correlation. The reverting speed and revenue showed a negative correlation. The short-term volatility had a positive correlation toward the fluctuation range of the revenue. The simulation results indicate that this enhanced method can produce more accurate information for a better assessment of the PPP project under a wide range of uncertainty scenarios, allowing for the best decision making by the government.
Highlights
The rapid industrialization and urbanization in China have significantly increased the discharge of urban sewage, which requires a large number of sewage treatment facilities [1,2]
We can see that the government subsidy increased about 115% when the mean value of short-term uncertainty increased to 1, compared with the revenue without the short-term uncertainty
This article identifies the effect of short-term uncertainty in the application of Real Option Theory (ROT)
Summary
The rapid industrialization and urbanization in China have significantly increased the discharge of urban sewage, which requires a large number of sewage treatment facilities [1,2]. Due to limited public funds, Public-Private Partnerships (PPP) has been adopted in the development of these urgently needed facilities, encouraging investments from potential private resources [3]. There are advantages for both the government and the private sector. This partnership allows the government to mitigate their financial burden, which would be exacerbated by large up-front investments, and it allows the government to pay for the usage of the project over time, but not immediately [4]. The PPP model allows the government to focus on their tasks by transferring this infrastructure construction demand to private sectors
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