Competition and Regulation in Network Industries: Not an Easy Balance to Strike. Comments on Koski and Kretschmer*

Network industries present several counterintuitive aspects. This peculiarity has attracted particular attention among policymakers, but public intervention has not always been irreproachable. A continuously improving appraisal of network industries tends to allow a better informed policy action and a good balance between otherwise potentially competing policies (competition policy and sector-specific regulation in the first place, but also innovation and standardization policies).     

Pricing Final Indemnification Payments to Private Sponsors in Project-Financed Public-Private Partnerships: An Application of Real Options Valuation

The extraordinary global growth in the private funding of public infrastructure projects in the form of public‐private partnerships (or PPPs) is expected to have major social and economic benefits—benefits that result in large part from improving the allocation of project risks between the public and private sectors. But with the financial crisis and severe tightening of credit likely to limit the financing and delivery of new projects, both project participants and their financiers need to manage the technical, economic, legal, and political complexities of infrastructure projects more carefully, especially in less traditional infrastructure deals that involve complex operations, new assets, or emerging markets. This paper proposes and illustrates the application of the real options valuation approach to a critical feature of most PPPs: establishing the final “indemnification” amount to be paid by a public administration to private partners in the project financing of those PPPs that face substantial market risks. In demonstrating this approach, the authors use the case of the Pedemontana Lombarda toll road, a major transportation infrastructure project in Northern Italy for which financial plans have been filed and whose start is now pending. The main function of real options in this case is to capture the effects on value of the major market risk in such projects—namely, the uncertainty about volume of traffic on the new road. The authors interpret the final indemnification price as the value of a real put option sold by the awarding authority to private investors (in the case of a project that would otherwise be unprofitable and have a negative NPV). The put option takes the form of a clause in the concession contract that gives investors the right, under certain circumstances, to sell the toll road back to the government for a fixed sum (in this case, €2.9 billion). According to the authors, this valuation approach is likely to be helpful in any kind of infrastructure project that faces risk stemming from the unpredictability of market demand and future revenue streams.     

Arranger Certification in Project Finance

Using a sample of 4,122 project finance loans worth $769 billion arranged from 1991 to 2005, we demonstrate that certification by prestigious lead arranging banks creates economic value by reducing overall loan spreads compared to loans arranged by less prestigious arrangers. Banks participating in these loan syndicates, rather than the project sponsors, pay for this certification. They do so by allowing top tier arrangers to keep larger fractions of the upfront arranging fees. Results are robust to the correction for the endogenous choice of loans by prestigious arrangers and indicate that certification is even more valuable during periods of extreme financial stress.     

The exact Taylor formula of the implied volatility

In a model driven by a multidimensional local diffusion, we study the behavior of the implied volatility \({\sigma}\) and its derivatives with respect to log-strike \(k\) and maturity \(T\) near expiry and at the money. We recover explicit limits of the derivatives \({\partial_{T}^{q}} \partial_{k}^{m} \sigma\) for \((T,x-k)\) approaching the origin within the parabolic region \(|x-k|\leq\lambda\sqrt{T}\), with \(x\) denoting the spot log-price of the underlying asset and where \(\lambda\) is a positive and arbitrarily large constant. Such limits yield the exact Taylor formula for the implied volatility within the parabola \(|x-k|\leq\lambda\sqrt{T}\). In order to include important models of interest in mathematical finance, e.g. Heston, CEV, SABR, the analysis is carried out under the weak assumption that the infinitesimal generator of the diffusion is only locally elliptic.