Optimal Investment Timing for Flood Risk Adaptation in Presence of Trend, Seasonality and Stochastic Interest Rates

This paper deals with ‘investment timing’, or how to make decisions on long-term investments to mitigate catastrophic risk where the risk is driven by trends and seasonality, and interest rates vary stochastically over time. Our model combines real options theory, extreme value theory and risk pricing theory to provide a useful decision-support system for catastrophic risk management. Using a case study of flood risk management for New York City, we show that ignoring seasonality, trend or risk aversion can lead to underestimation of the investment values and also unnecessary delay in the project investment. We also show that consideration of stochastic interest rates can provide substantial benefits when investment is optimally timed and accelerate the process of climate change adaptation