Climate change adaptation projects of transport facilities: is a demonstrator necessary?

Transport facilities are increasingly threatened by the climate-change related natural disasters in recent years. In order to incentivize the transport facility operators to engage in climate change adaptation, governments may provide subsidies to the adaptation investment. Due to the substantial uncertainties in the outcomes of the adaptation projects, the government can set up an "experiment" project, which can be used as a demonstrator. In this paper, we develop real-option game models to investigate the transport facility operators' adaptation investment under static stochastic demand and time-varying stochastic demand. Meanwhile, the government's optimal decisions on whether to set up a demonstrator and the related subsidy policies are also examined. We find that under static stochastic demand, the government prefers to set up a demonstrator if the marginal benefit of the adaptation capacity is larger than its marginal cost, or the demonstration effect is high enough. Under time-varying stochastic demand, the government prefers to set up a demonstrator when the demand volatility is low. Moreover, increasing demand volatility requires less (or more) subsidy, when the demonstrator is (or is not) set up. Increasing demand volatility leads to postponement of the adaptation timing and more adaptation investment, irrespective of whether there is a demonstrator.