Why Risk Factors Should Be Incorporated in Decision Models Regarding Coastal Hazard Management

Abstract

A set of scenarios is developed based on decision-theoretic models from finance that represent the dynamics of the decision-state facing a planner concerning coastal hazard management. These scenarios illustrate why risk factors are important in the decision-making process and how they can be incorporated into decision models. The exercise potentially suggests improvements and refinements to presently used Cost-Benefit Analysis procedures allowing for a greater range of risk and uncertainty, and offers new tools that can aid in decisions concerning provision of shoreline stabilization. The outcomes of these scenarios justify better planning and control of existing and future building, and that of post-storm policies. Lastly, these models allow us to explore the range of our understanding of coastal processes and interactions with shoreline stabilization projects, and can identify new and useful data needed in coastal management and hazard management decisions. INTRODUCTION In this short paper, we explore the suitability of appropriate decision-theoretic models from finance theory that can incorporate risk and uncertainty in the decision environment as well as evaluate tradeoffs between risk and economic returns (Kreps 1990, Levy and Sarnat 1994, Pratt et al. 1995). These models have been adapted and applied to investment decisions that are made under conditions of uncertainty (Dixit and Pindyck 1993). The models potentially suggest improvements and refinements to the present use of CBA models, and offer the decision-maker methods that can handle dynamics and exogenous risk factors in determining optimal levels of shoreline stabilization to society. These models and efforts can contribute to the new dialog about public policy responses to catastrophes and natural hazards, long-term efforts to reduce associated risks and public' costs, and concerns about future risks (Mileti 1999, Psuty and Ofiara 2002). INSIGHTS FROM FINANCE THEORY AND APPLICATIONS We begin by examining Cost-Benefit Analysis and then portfolio-theoretic models, Cost-Benefit Analysis (CBA) involves evaluation of costs and benefits/returns. Usually projects extend over time and interest earned on investments cause the value of a dollar to change over time; hence a dollar in the future is not equal to a dollar in the present. To account for this difference one expresses monetary measures in terms of a base year by discounting (also referred to as the present value). The net discounted benefit, i.e., discounted benefits less discounted costs is calculated, and those projects that yield a positive net discounted benefit are selected. In the presence of many similar projects the rule is to select the project(s) that yields the largest net discounted benefit. ' Assistant Professor of Public Policy and Management, Muskie School of Public Service, University of Sourthern Maine, 96 Falmouth Street, Portland, ME 04104 USA, dofiara@usm.maine.edu and Visiting Scholar, Institute of Marine and Coastal Sciences, Rutgers University. 2 Professor of Coastal Sciences, Institute of Marine and Coastal Sciences, 71 Dudley Road, Rutgers University, New Brunswick, NJ 08901-8521 USA, psuty@imcs.rutgers.edu.