Evaluation of Minimum - Traffic Guarantees as Real Options Using CAPM and Monte Carlo Simulations

The government of Turkey actively promotes public-private partnership (PPP) models in infrastructure projects. The risks associated with PPP agreements have the potential of incurring a heavy fiscal burden on the state through contingent liabilities, including government guarantees. It is therefore important to distribute risk among contract parties, according to the risk-management capacities of each. Therefore, PPP project agreements including government guarantees must be well-structured and managed by all the responsible government institutions. In the context of BuildOperate-Transfer (BOT) projects, governments are expected to cover political and force majeure risks. Government also guarantees take-up of project output. In Turkey, however, the government also assumes responsibility for risks more usually assumed by the private sector, including financial, construction, and availability risk. This situation can create serious fiscal problems if the associated contingent liabilities are realized. The study, first presents an overview of the legal and institutional frameworks relevant to BOT projects in Turkey, focusing on the explicit contingent liabilities and associated risks. The focus of the study is the minimum-traffic government guarantees to reduce the demand risk in toll-road projects. Three guarantee types, namely plain guarantee, guarantees capped at a certain portion of the investment cost, and guarantees with a ceiling on the income of the project company, will be evaluated and compared by Monte Carlo simulation. This study first aims to illustrate the methods of modelling various guarantee types as real options in a BOT project. Another important objective is to calculate guarantee values in the case of a toll-road BOT project, using real option pricing and the Capital Asset Pricing Model (CAPM). The study also comes up with one suggested criterion for finding the optimum levels of various minimum-traffic guarantees for a given project. Additionally, the study introduces a criterion for measuring the risk reduction capacity of guarantee types tested in the case illustration. Taking into account the findings and the results of the study, some practical policy recommendations are provided for the government on the evaluation, monitoring, and management of similar contingent liabilities and risks in line with international best practice. Keywords: Public-private partnerships, contingent liabilities, risk analysis infrastructure, Turkey.