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Safeguarding Infrastructure Projects Against Disruptive Events With Term Extension Clause

Infrastructure concessions, especially for transport projects, are long-term investments subject to demand volatility. Yet disruptive events, such as the Covid-19 pandemic, may negatively affect demand for traffic infrastructure, thus impacting the cash flows of such projects and decreasing the return of the concessionaire. Historical demand series shows that these events are more frequent than they would appear, but that their effects are usually transitory. In the analysis of passenger demand series in major airports in the United States, Europe, and Brazil, it is apparent how the Covid-19 pandemic affected demand for a period of time. Nonetheless, after the second year of the pandemic, demand resumed its historical levels with an observable time lag, but at a fast pace. We propose an approach to hedge the effects of such disruptive events by considering a concession term extension proportional to the observed reduction in the demand and the length of this reduction. We model this mechanism as a European Call Option on the time-term extension of the concession contract. Traffic demand is modeled as a mean reversion to which negative Poison jumps are added to simulate such disruptive events. Results are then compared to the case without real options.