Many volatile factors influence the performance of infrastructure and these yield a range of uncertainties when forward-looking investment decisions are being considered. This article is restricted to consideration of physical infrastructure, which has a wide spectrum of such factors. It includes physical events such as earthquakes that are beyond the influence of humankind, other events for each of which there is a very small probability of occurrence, and events that will almost certainly occur at some point within any reasonable period of time. It also includes economic events relating to uncommon financial episodes and common, but uncertain, volatility in demand and cost. Rare physical events have implications for investment in infrastructure that provides some mitigation of the effects of these events. In so doing, there is a trade-off between providing in advance for remotely likely but substantial events in specific, and usually costly, redundancy infrastructure, and having an economy with the resources to deal ex post with natural disasters. Obviously, some intermediate position will be socially desirable.
Replacement Investment Decisions under Jump Diffusion Processes
