Managing cost overrun risk in project funding allocation

Managing cost overrun risk in project funding allocation

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Article ID: iaor20052502
Country: Netherlands
Volume: 135
Issue: 1
Start Page Number: 127
End Page Number: 153
Publication Date: Mar 2005
Journal: Annals of Operations Research
Authors: , ,
Keywords: financial, risk
Abstract:

This paper discusses decision making of project funding allocation under uncertain project costs. Because project costs are uncertain and funding allocations may not necessarily match the costs required, each project is inherently subject to a cost overrun risk (COR). In this paper, a model is proposed in which project cost is treated as a factor with a probability density function. The decision maker then allocates the total funding to the projects while minimizing a weighted sum of mean and variance of the COR of the project portfolio. Some properties of project COR are derived and interpreted. Optimal funding allocation, in relationship to factors such as various project sizes and riskiness, project interdependency, and the decision maker's preference, is analyzed. The proposed funding allocation model can be integrated with project selection decision-making and provides a basis for more effective project control.

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