university of colorado copyright © 2005 james alleman. all rights reserved. james alleman...
TRANSCRIPT
University of Colorado
Copyright © 2005 James Alleman. All Rights Reserved.
James Alleman
Transatlantic DialogueMontpellier, France 22 November 20055
Regulatory Failure
Time for a New Policy Paradigm
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Agenda
OverviewIncorrect FoundationsLack of Dynamic EfficiencyLessonsConclusion & Further Research
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Agenda
Overview
Transatlantic Dialogue Broadband Conference
Agenda
Cost of regulation > benefits
Wrong modelsEconomic dynamics
Transatlantic Dialogue Broadband Conference
Agenda
Cost of regulation > benefitsAdministrative costs, Regulatory capture and Other effects
Transatlantic Dialogue Broadband Conference
Agenda
Cost of regulation > benefitsAdministrative costs, Regulatory capture and Other effects
Wrong models Misallocation of resourcesA lowering of social welfare
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Agenda
OverviewIncorrect FoundationsLack of Dynamic Efficiency
Unrecognized Opportunity CostsSunk Costs
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Agenda
OverviewIncorrect Foundations
CompetitionFaux Success Optimal Pricing
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Agenda
OverviewIncorrect FoundationsLack of Dynamic EfficiencyLessons
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Agenda
OverviewIncorrect FoundationsLack of Dynamic EfficiencyLessonsConclusion & Further Research
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Agenda
OverviewIncorrect FoundationsLack of Dynamic EfficiencyLessonsConclusion & Further Research
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Overview/Literature Review
Regulatory ModelsDynamic ModelsReal Options Approach
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Investments DistortionsƒWrong incentivesƒAverch-Johnson
Static/Comparative StaticCertainty
Regulatory Models
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Objectives
Uncertainty ModelledDynamic ModelsRegulation ModelledCost of Regulation Estimated
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Agenda
OverviewIncorrect FoundationsLack of Dynamic Efficiency
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Agenda
Overview/Literature ReviewReal OptionsRegulatory DistortionsInvestment CriterionImplications for RegulationFuture Research
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Overview/Literature Review
Regulatory ModelsDynamic ModelsReal Options Approach
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Investments DistortionsƒWrong incentivesƒAverch-Johnson
Static/Comparative StaticCertainty
Regulatory Models
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Growth ModelsCertainty
ƒComplete informationƒExogenous depreciation
Dynamic Models
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Valuation ModelsƒProject valuationsƒNo retail pricing
No Regulatory Models
Real Options
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Agenda
OverviewReal Options
ƒWhat are they?ƒTypes of Options
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
What Are Real Options?
Financial Option AnalogyƒRight ƒNot obligationƒUpside potential (profit)ƒLimit downside risk (loss)
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
DeferƒTo wait to determine if a "good" state-of-nature obtains
Types of Options
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
DeferAbandon
ƒTo obtain salvage value or opportunity cost of the asset
Types of Options
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
DeferAbandon Shutdown & Restart
ƒTo wait for a "good" state-of-nature and re-enter
Types of Options
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
DeferAbandon Shutdown & RestartTime-to-build
ƒTo delay or default on project - a
compound option
Types of Options
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
DeferAbandon Shutdown & RestartTime-to-buildContract
ƒTo reduce operations if state is worse than expected
Types of Options
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
DeferAbandon ...ContractSwitch
ƒTo use alternative technologies depending on input prices
Types of Options
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Defer...ContractSwitchExpand/Growth/Learn
ƒTo expand if state-of-nature is better than expected
Types of Options
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
DeferAbandon Shutdown & RestartTime-to-buildContractSwitchExpand/Growth/Learn
Types of Options
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Agenda
Overview/Literature ReviewReal OptionsRegulatory Distortions
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Assumptions/Model
q1
1 - q1
go
stop
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Regulatory Distortions
Revenue ConstraintƒRate-based, rate-of-returnƒPrice Capsƒ Interconnection pricesƒUNEs price ceilingƒModelled as "Good" Ceiling
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Regulatory Distortions
q1
1 - q1
stop
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Regulatory Distortions
q1
1 - q1
stop
revenue constraint
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Regulatory Distortions
Revenue ConstraintƒRate-based, rate-of-returnƒPrice CapsƒUNEs price ceilingƒModelled as "Good" Ceiling
Defer
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Defer: To wait to determine if a "good" state-of-nature obtains
Regulatory Distortions
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Value in Waiting Like Call OptionInfluences:
ƒuncertaintyƒ foregone profits
Choice: Max [immediate investment, waiting, 0]
Delay: Waiting to Invest
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Revenue ConstraintDefer: To wait to determine if a "good" state-of-nature obtains
Abandon: To obtain salvage value or opportunity cost of the asset
Description of Options
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Regulatory Distortions
Price CeilingsƒRevenue constraintsƒPrice setting (UNEs/Interconnection)
Obligation to ServeƒUniversal service
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Regulatory Distortions
Price CeilingsƒRevenue constraintsƒPrice setting (UNEs)
Obligation to ServeƒUniversal service
Lack of delay
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Regulatory Distortions
Price CeilingsƒRevenue constraintsƒPrice setting (UNEs)
Obligation to ServeƒUniversal service
Lack of delayLack of abandonment
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Regulatory Distortions
Price CeilingsƒRevenue constraintsƒPrice setting (UNEs)
Obligation to ServeƒUniversal serviceƒPay telephones
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Regulatory Distortions
Price CeilingsƒRevenue constraintsƒPrice setting (UNEs)
Obligation to ServeƒUniversal serviceƒPay telephones
Lack of abandonment
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Regulatory Distortions
Price CeilingsƒRevenue constraintsƒPrice setting (UNEs)
Obligation to ServeƒUniversal service
Lack of delayLack of abandonment
ƒPay telephonesLack of abandonment
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Regulation Distortions
CostlyƒCash flow constrainedƒDelay-cash flow constrainedƒAbandon-cash flow constraint
Unrecognized Cost
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Agenda
Overview/Literature ReviewReal OptionsRegulatory DistortionsInvestment Criterion
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
t=0 t=1
S0RS0
S1
A Risk-Neutral Model
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
t=0 t=1
S0RS0
S1
A Risk-Neutral Model (Continuous Additive)
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
A Risk-Neutral Model (Continuous Additive)
t=0 t=1
S0RS0
V S1
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
S0
VK
Probability
f(V)
Call Option
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Call Option
S0
VK
V-K
Probability
f(V)
Payoff : P(V)
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Call Option Price
S0
VK
V-K
Probability
f(V)
Payoff : P(V)
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
3.2 Defer Option
Present value of a project’s future cash flow
Investment toacquire the project assets
Length of time the decision may be deferred
Time value of money
Riskiness of the project assets
Stock price
Exercise price
Time to expiration
Risk-free rate of return
Variance of returnson stock
Defer Option Call Option
S
K
T
rf
2
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Example
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
ƒ PV[Cash out] = PV[KT]
= 110/1.06 = 103.8ƒ PV[Cash in] = S = E[ PV[S1]]
= 100ƒ NPV = PV[cash in] – PV[cash out] = 100 – 103.8 = - 3.8
Net Present Value
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
S=100
V
K=110/1.06=103.8
V-K
ROV (Real Option Value)
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
3.4 ExNPV
Expanded NPV10.2 M
- 3.8 M
6.4 M
NPV + ROV = ExNPV
= Flexibility value
to defer
= Conventional
Value of Project
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
When is ExNPV = 0, when NPV < 0?
Methodology
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
When is ExNPV = 0, when NPV < 0 ?
Wait and watch the market!
Do not invest
ExNPV > 0 ExNPV < 0
ExNPV = 0
Methodology
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
If NPV < 0, when is ExNPV = 0? i.e.
ExNPV = ROV + NPV = 0
Methodology
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
SV
K
V-K
Methodology
ƒ When is ExNPV = 0, give NPV < 0?ƒ ExNPV = ROV + NPV = 0
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
: Normal distribution (0,1): fN(v)
Solve
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
LHS ( left hand side )
Solve
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
LHS ( left hand side )
Solve
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
D* = 0.2773
Solve
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
ExNPV > 0 ExNPV < 0
Criterion
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
ExNPV > 0 ExNPV < 0
LHS > 0 LHS < 0
Criterion
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Implications for Regulation
Impact on "riskiness" Reduces
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Agenda
Overview/Literature ReviewReal OptionsRegulatory DistortionsInvestment CriterionImplications for Regulation
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Agenda
Overview/Literature ReviewReal OptionsRegulatory DistortionsInvestment CriterionImplications for RegulationFuture Research
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Future Research
Empirical EstimatesInvestment
ƒEndogenous ƒEconomic depreciation
Ramsey Pricing
Transatlantic Dialogue Broadband Conference James Alleman & Paul Rappoport Colorado University & Temple University
Dr. James AllemanUniversity ColoradoCB 422 UBSBoulder, CO 80309-0422
phone: +1 303 443-4465facsimile: +1 303 492-1112mobile: +1 917 294-1688e-mail: [email protected] Dr. Paul RappoportTemple UniversityBroad StreetPhiladelphia, PA 19075
phone: +1 215 204 5025e-mail: [email protected]
Contact Information