Robust portfolio optimization considering the value of flexibility: Application to WTE technology portfolios

Abstract

Optimizing waste-to-energy (WTE) technology portfolio is crucial for large waste treatment enterprises to attain sustainable profits and minimize risks in uncertain environments. A key issue is accurately assessing the return of individual technologies and mitigating the impact of parameter variations in portfolio optimization. Traditional portfolio methods rely heavily on precise input parameters. However, when these parameters inevitably fluctuate under uncertain conditions, the resulting strategies may become unreliable and not meet the expected return objectives. This paper introduces an innovative integration of the real options (RO) approach and robust portfolio optimization (RPO) to evaluate WTE technology portfolios. The proposed model assumes parameters fluctuate within an uncertainty set, overcoming the limitations of traditional portfolio models that rely on precise input parameters. It ensures the selected portfolio meets investors’ goals under worst-case scenarios and provides reassurance for investors. The proposed model compares favorably to the existing RPO models by incorporating the value of flexibility, which reflects realistic decision-making processes and better supports portfolio optimization. The empirical results demonstrate that the portfolio strategies generated by the proposed approach improved portfolio value and effectively ensured the investors’ return objectives, relative to portfolio strategies generated by traditional models. The methodologies and outcomes of this study offer valuable insights for investors, providing guidance on optimal investment strategies and assisting governments in policy optimization.