Vahdatmanesh, M and Firouzi, A (2018) Price risk management in BOT railroad construction projects using financial derivatives. Journal of Financial Management of Property and Construction, 23(3), pp. 349-362. ISSN 1366-4387
Abstract
Purpose: Railroad transit infrastructures are amongst major capital-intensive projects worldwide, which impose significant risks to the contractors of build-operate-transfer projects because of the fluctuations in steel price fluctuation. The purpose of this paper is to introduce a methodology for hedging steel price risk using financial derivatives. Design/methodology/approach: Cox–Ross valuation lattice has been used as an option valuation model for determining option’s price for the construction companies involved in fixed-price railroad projects. A sensitivity analysis has been conducted using the financial option Greeks to evaluate the impacts of option’s pricing factors in the total price of option. Findings: The result of valuation shows that European options cost to safeguard against the effects of price risk is only a fraction in contrast to the total cost of steel procurement for a typical railroad construction company. This confirms that using this kind of financial derivative is a beneficial yet effective approach for hedging steel price risk for railroad construction companies. Practical implications: The applicability of the financial derivatives, both exchange-traded and over-the-counter instruments, is evident in broad financial industry. This paper shows how European options can be readily used for risk management of a typical railroad project, and explains the methodology in a step-by-step procedure. Originality/value: Although the financial engineering literature is rife of theory and application of derivatives in various contexts, to the best knowledge of authors there is only few papers on the application of these well-developed financial instruments for risk management in construction industry. This study intends to illustrate how financial derivatives can add value to risky construction projects and shed new light in this important application area.
| Item Type: | Article |
|---|---|
| Uncontrolled Keywords: | Cox-Ross model; European option; financial derivatives; railroad project; risk management; steel |
| Index terms: | pricing, option, construction industry, build-operate-transfer, risk management, construction company, sensitivity analysis, methodology, construction project |
| Subjects: | contractual arrangements, economic analysis, risk assessment, organization, industry analysis, environmental hazards, decision analysis, production management, research methods |
| Topics: | Risk Management, Sustainability, Procurement, Business Strategy, Project Management, Research Practice |
| Descriptive scope: | 3 PCT |
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