The Challenges of Regulation Using Real Options - A Response to Peter Monkhouse

The regulation of infrastructure by the ACCC and other economic regulators in Australia is based around net present value estimation techniques. Recently, Monkhouse (2007) suggested that real options valuation would provide better incentives for investment in infrastructure, but did not elucidate how a regulatory system based on real options valuation should operate. This paper endeavours to sketch the outlines of such a system, and finds that it has considerable promise as an alternative to the status quo, provided an appropriate technique for addressing monopoly rents can be developed.