Department of Applied Finance and Actuarial Studies
Dr. Chi Truong Seminar
Past Seminar from the archive
- Topic: A Real Option Framework for Catastrophic Loss under Climate Change
- Speaker: Dr. Chi Truong, Postdoctoral Research Fellow at the Faculty of Business and Economic, Macquarie University.
- Was held: 25th May, 2011, (Wed)
Methods for evaluating adaptation measures that reduce potential losses from catastrophes (e.g. floods, storms, droughts and bushfires) are and will be of significant interest to local governments. The frequency of these extreme events is likely to increase under climate change and their severity is also likely to increase due to economic and population growth. Previous studies have mostly examined only static adaptation strategies, i.e. adapt now or never adapt. For studies that examine dynamic adaptation strategies, numerical dynamic programming computation is required. In this paper, a framework that links the Loss Distribution Approach often used in insurance modelling with real option theory is provided. The closed functional form for the option to invest enables easy computation of the optimal investment rule. Empirical results for a bushfire management project show that ignoring the flexibility of the adaptation decision as in previous studies may result in significant losses or non-optimal timing of investments.