A Model Robust Real Options Valuation Methodology Incorporating Climate Risk

We propose a simple generalization of the Brennan-Schwartz approach to real option valuation of a mining project that incorporates disaster risk using a Poisson point process to model arrivals. Using techniques from the field of robust performance analysis, we are able to calculate upper and lower bounds over all the probability models within a certain distance from the original model. We suggest two different approaches for mine valuation based on this technique. The first, and more direct approach, calibrates the distance of probability measures from a set of known mine transactions and prices a mine (with currently unknown value) using the modeling distance from the training set of mines. The second approach uses historical precipitation data from a mine site, to calculate a worst case disaster arrival process from the actual physical data, and the mine is then priced using this process.