Modeling Airport Business Risks, Enplanement Volatility, and Valuation of Flexibility Options in Airport Expansion Projects

Abstract

Airport capital improvement programs involve considerable flexibility in investment timing and engineering design. Even though the valuation of flexibility options may depend on several factors, the volatility of future airport activity levels, which largely defines the business risk for airport operators, makes up the focus of the present paper. As such, the paper proposes a model that can be used to value two types of flexibility options common in airport expansion projects. The first type of option—flexibility in investment timing decisions—creates value by conditioning capacity expansion decisions on trends in airport activity levels. The second, flexibility in engineering design, permits operators to influence their demand composition and to reconfigure airport facilities if their business environment changes unfavorably. A Monte Carlo simulation example also demonstrates the application of the proposed valuation model. The results show that flexibility options add economic value by reducing downside exposures and by providing the ability to increase capacity if enplanements stay on a rising trajectory. Moreover, the paper provides a comparison of enplanement growth rates by airport size for the largest 140 U.S. airports from 1990 to 2016. The analysis shows that medium airports may be uniquely positioned to benefit the most from flexible design approaches. For these airports, results imply higher exposures to excess capacity risks because of the increased persistence of losses, despite the higher year-on-year volatility of small airports.