Professional Documents
Culture Documents
Risk Analysis
Risk Analysis
401
Project Management
Spring 2006
Risk Analysis
Decision making under risk and uncertainty
Financing&Evalua
tion
Risk
Analysis&Attitude
Risk Management Phase
RISK MNG
Risk management (guest seminar 1st wk April)
Assessment, tracking and control
Tools:
Risk Hierarchical modeling: Risk breakdown structures
Risk matrixes
Contingency plan: preventive measures, corrective
actions, risk budget, etc.
Decision Making Under
Risk Outline
Risk and Uncertainty
Risk Preferences, Attitude and
Premiums
Examples of simple decision trees
Decision trees for analysis
Flexibility and real options
Decision making
Uncertainty and Risk
“risk” as uncertainty about a
consequence
Preliminary questions
What sort of risks are there and who
bears them in project management?
What practical ways do people use to
cope with these risks?
Why is it that some people are willing to
take on risks that others shun?
Some Risks
Weather changes Community opposition
Different productivity Infighting &
(Sub)contractors are acrimonious
Unreliable relationships
Lack capacity to do work Unrealistically low bid
Lack availability to do Late-stage design
work changes
Unscrupulous
Financially unstable
Unexpected subsurface
conditions
Late materials delivery Soil type
Lawsuits Groundwater
Labor difficulties Unexpected Obstacles
Unexpected Settlement of adjacent
manufacturing costs structures
Failure to find High lifecycle costs
sufficient tenants Permitting problems
…
Importance of Risk
Much time in construction
management is spent focusing on risks
Many practices in construction are
driven by risk
Bonding requirements
Insurance
Licensing
Contract structure
General conditions
Payment Terms
Delivery Method
Selection mechanism
Outline
Risk and Uncertainty
Risk Preferences, Attitude and
Premiums
Examples of simple decision trees
Represent
Flow of time
Decisions
$1.61 M
repair
$0.55 Investment PV
$1.43
•Pessimistic rule
• min (1, 1.61) = 1 replace the bridge
•The optimistic rule (maximax)
• max (1, 0.55) = 0.55 repair … and hope it
works!
The bridge case – known
prob’ties
$ 1.09 million
replace
$1.61 M
0.25
repair 0.5
$0.55 Investment PV
0.25
$1.43
Data link
The bridge case –
decision
The pessimistic rule (maximin =
minimax)
Min(Ei) = Min (1.09 , 1.04) = $
1.04 repair
In this case = optimistic rule
(maximax)
Awareness of probabilities change
risk attitude
Other criteria
Most likely value
For each policy option we select the
outcome with the highest probability
Expected value of Opportunity Loss
To buy soon or to buy later
-100
Buy soon
-100+5 = -95
-100+5+30 = -65
Actualization = 5
To buy soon or to buy later
-100
Buy soon
1
.7
125 100 65
Expected (mean) value
E = (0.5)(125) + (0.25)(95) + (0.25)(65) =
-102.5
Utility value:
f(E) = ∑ Pa * f(a) = 0.5 f(125) + 0.25 f(95) + .
25 f(65) =
Defining the Preference
Function
Suppose to be awarded a $100M
contract price
Early estimated cost $70M
70 $
Notion of a Risk
Premium
A risk premium is the amount paid by a
(risk averse) individual to avoid risk
Risk premiums are very common – what
are some examples?
Insurance premiums
Higher fees paid by owner to reputable
contractors
Higher charges by contractor for risky work
$5000
satisfaction>.25 instead
Can get .25 satisfaction for a sure f-
1(.25)=$5000
EMV
(0.5)(-1) + (0.5)(1) = 0
Quality
Replace
MTTF 10.0000
Cost 1.00
C3
MTTF 6.6667
Cost 0.30
C4
MTTF 5.7738
Cost 0.00
m: maximizing bridge duration, minimizing cost
Consequences: Cost
Components: Delay cost, storage cost,
cost of reorder (including delay)
Procurement Tree
Decision Making Under
Risk
Risk and Uncertainty
Risk Preferences, Attitude and
Premiums
Decision trees for representing
uncertainty
Decision trees for analysis
…
A simulation calculates multiple scenarios of a model
by repeatedly sampling values from the probability
distributions
Computer software tools can perform as many trials
(or scenarios) as you want and allow to select the
optimal strategy
Monetary Value of
$6.75M Bid
Monetary Value of $7M
Bid
With Risk Preferences:
6.75M
With Risk Preferences:
7M
Larger Uncertainties in
Cost
(Monetary Value)
Large Uncertainties II
(Monetary Values)
With Risk Preferences for
Large Uncertainties at
lower bid
With Risk Preferences for
Higher Bid
Optimal Strategy
Decision Making Under
Risk
Risk and Uncertainty
Risk Preferences, Attitude and
Premiums
Decision trees for representing
uncertainty
Examples of simple decision trees
Recommended:
Meredith Textbook, Chapter 4 Prj
Organization
Risk management and insurances – Stellar
Risk - MIT libraries
Haimes, Risk modeling, assessment, and management