Location and Development of Light Rail Stations under Demand Uncertainty: A Real Options Based Framework

Given the deepening awareness of the limited nature of fossil fuel reserves and the environmental consequences of consuming it, the increasing appetite for better public transportation infrastructure persists worldwide. A huge amount of investments and resources is being injected into the development of transportation infrastructures, including light rail, as the need for better and faster transportation is correlated with the economic development of a country. However, there is a serious lack of understanding regarding the underlying uncertainties, as well as their impact on the performance of these infrastructure projects. As a consequence, performance results that are lower than the forecasts are very common in rail transportation and financial or social benefit of light rail transits deviate hugely from what is expected. In many of these cases, either the overall cost of the project turns out to be much higher or the patronage proves to be far less than originally forecasted. This study aims at reducing such a gap in the literature by considering the uncertain nature of the demand. More specifically, this study proposes a real options-based framework for the feasibility analysis of the potential locations of light rail stations. First, it estimates the demand for each proposed station location considering the endogenous uncertainties involved in the forecasting of demand. Second, the feasibility of different station development scenarios is analyzed using the net present value (NPV) method. Third, a real options analysis is done on various development scenarios by considering the possible values of incorporating flexibility in the development. Fourth, based on the level and nature of the uncertainty in the station demand for each location, the economic benefits of incorporating flexibility for the station-development are quantified. Using a case study approach, the proposed model is applied for a station location on Dubai Metro Purple Line. The results suggest that recognizing the major uncertainties at an early stage and incorporating flexibility into the system design accordingly pays off under certain circumstances.