A practical method for incorporating Real Options analysis into US federal benefit-cost analysis procedures

Abstract

This research identifies how Real Options (RO) thinking might acceptably and effectively complement the current mandates for Benefit-Cost Analysis (BCA) defined by the Office of Management and Budget (OMB) in Circular A-94. The research examines opportunities for improving economic analysis using mandated rules for a large complex system, highlights where improvements can be made with RO thinking, and proposes a framework that can be optionally and generically applied to mandated decisionmaking guidelines. The framework relies on a simple spreadsheet analysis that is augmented with Monte-Carlo simulation. The proposed approach complements existing practices and should be easy to integrate with current tools, procedures, staff, and resources.This approach builds upon a careful analysis of Federal mandates for benefit-cost analyses, the implementing directions of the OMB, and the way these guidelines are followed by practitioners who have to deal with the particularities that exist in the field. The current practice was determined by examining several case studies of work for the Federal Aviation Administration (FAA) and through discussions with FAA officials knowledgeable about the BCA methods in practice. The proposed approach with FAA Airport Benefit-Cost Analysis Guidelines was applied to a Hypothetical Project for illustrative purposes.