Optimal investment and location decisions of a firm in a flood risk area using impulse control theory

Johanna Grames, Dieter Grass, Peter M. Kort, Alexia Prskawetz

Research output: Contribution to journalArticleScientificpeer-review

Abstract

Flooding events can affect businesses close to rivers, lakes or coasts. This paper provides an economic partial equilibrium model, which helps to understand the optimal location choice for a firm in flood risk areas and its investment strategies. How often, when and how much are firms willing to invest in flood risk protection measures? We apply Impulse Control Theory and develop a continuation algorithm to solve the model numerically. We find that, the higher the flood risk and the more the firm values the future, i.e. the more sustainable the firm plans, the more the firm will invest in flood defense. Investments in productive capital follow a similar path. Hence, planning in a sustainable way leads to economic growth. Sociohydrological feedbacks are crucial for the location choice of the firm, whereas different economic settings have an impact on investment strategies. If flood defense is already present, e.g. built up by the government, firms move closer to the water and invest less in flood defense, which allows firms to generate higher expected profits. Firms with a large initial productive capital surprisingly try not to keep their market advantage, but rather reduce flood risk by reducing exposed productive capital.
Original languageEnglish
Pages (from-to)1051-1077
JournalCentral European Journal of Operations Research
Volume27
Issue number4
DOIs
Publication statusPublished - Dec 2019

Fingerprint

Investment decision
Optimal investment
Impulse control
Location decision
Control theory
Flood risk
Investment strategy
Economics
Location choice
Partial equilibrium model
Water
Flooding
Coast
Economic growth
Government
Profit
Firm value
Planning

Keywords

  • optimal investment
  • location choice
  • flood
  • socio-hydrology
  • impulse control theory
  • sustainability

Cite this

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abstract = "Flooding events can affect businesses close to rivers, lakes or coasts. This paper provides an economic partial equilibrium model, which helps to understand the optimal location choice for a firm in flood risk areas and its investment strategies. How often, when and how much are firms willing to invest in flood risk protection measures? We apply Impulse Control Theory and develop a continuation algorithm to solve the model numerically. We find that, the higher the flood risk and the more the firm values the future, i.e. the more sustainable the firm plans, the more the firm will invest in flood defense. Investments in productive capital follow a similar path. Hence, planning in a sustainable way leads to economic growth. Sociohydrological feedbacks are crucial for the location choice of the firm, whereas different economic settings have an impact on investment strategies. If flood defense is already present, e.g. built up by the government, firms move closer to the water and invest less in flood defense, which allows firms to generate higher expected profits. Firms with a large initial productive capital surprisingly try not to keep their market advantage, but rather reduce flood risk by reducing exposed productive capital.",
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Optimal investment and location decisions of a firm in a flood risk area using impulse control theory. / Grames, Johanna; Grass, Dieter; Kort, Peter M.; Prskawetz, Alexia.

In: Central European Journal of Operations Research, Vol. 27, No. 4, 12.2019, p. 1051-1077.

Research output: Contribution to journalArticleScientificpeer-review

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