Abstract
A recent and exciting innovation in the field of corporate finance has been the application of financial derivatives theory to investment analysis. This study utilizes this insight to develop a model for pricing minimum revenue guarantees on toll roads. In some countries minimum revenue guarantees are a common way for government to subsidize private toll road development. A minimum revenue guarantee gives the owner the right to swap the revenue generated from an asset over a preceding period for a fixed amount of cash should they choose to do so. Unfortunately, minimum revenue guarantees create contingent liabilities for the granting government that are rarely, if ever, accounted for on the government's balance sheet. These liabilities may represent a significant unmanaged risk for many countries.
This study uses the arbitrage arguments developed for the pricing of financial options to build a model for quantifying the cost of the contingent risk to the government arising from minimum revenue guarantees on toll roads. This model may provide a framework for improved risk management strategies for countries that grant minimum revenue guarantees on toll roads.