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Risk anduncertainty incost benefitanalysis
Toolbox paper
APRIL 2006
Reference no.: 2002-17-001ISBN no.: 87-7992-041-1Written by: Karsten StæhrPublished: April 2006Version: 1.0©2006 Environmental Assessment InstituteFor further information please contact:Institut for Miljøvurdering /Environmental Assessment InstituteGl. Kongevej 5, 1
st
floorDK - 1610 Copenhagen VPhone: +45 7226 5800Fax: +45 7226 5839E-mail:imv@imv.dk
Web:www.imv.dk
Environmental Assessment Institute Risk and uncertainty in CBA 2006
1
List of contents
Abstract in English
..........................................................................3
Dansk resumé
.................................................................................4
1
Introduction
..............................................................................5
2
Risk and uncertainty
..................................................................9
3
Risk and uncertainty in CBA in theory
.......................................11
3.1
Cost benefit analysis under certainty
...................................................12
3.2
Cost benefit analysis under risk and uncertainty
..................................13
3.3
Project selection as portfolio choice
....................................................16
3.4
Should risk be considered in CBA?
......................................................17
4
Practical methods
...................................................................19
4.1
Adjusting the expected NPV to take account of risk aversion
................19
4.1.1 Cut off period
................................................................................19
4.1.2 Risk-adjusted discount rate
...........................................................20
4.1.3 Certainty equivalents
....................................................................20
4.1.4 Downward revision of benefits, upward revision of costs
................21
4.1.5 Safety margin
...............................................................................22
4.1.6 Precautionary principle
.................................................................22
4.2
Sensitivity analysis
.............................................................................23
4.2.1 Gross sensitivity analysis
..............................................................23
4.2.2 Stress testing
...............................................................................24
4.2.3 Combining gross sensitivity analysis and stress testing
.................26
4.3
Risk analysis using Monte Carlo simulation
.........................................27
4.3.1 Assigning probabilities
.................................................................27
4.3.2 Undertaking Monte Carlo simulations
............................................28
4.3.3 Presenting the results
...................................................................30
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Risk and Uncertainty in Cost Benefit Analysis
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