Académique Documents
Professionnel Documents
Culture Documents
Preliminaries
Announcements
Remainder
email Sharon Lin the team info by midnight, tonight Monday Feb 27 - Student Experience Presentation Wed March 1st Assignment 2 due
Today, recitation Joe Gifun, MIT facility Next Friday, March 3rd, Tour PDSI construction site
FEASIBILITY
DESIGN PLANNING
DEVELOPMENT CLOSEOUT
OPERATIONS
RISK MNG
Risk Hierarchical modeling: Risk breakdown structures Risk matrixes Contingency plan: preventive measures, corrective actions, risk budget, etc.
Risk and Uncertainty Risk Preferences, Attitude and Premiums Examples of simple decision trees Decision trees for analysis Flexibility and real options
Decision making
Some Risks
Unreliable Lack capacity to do work Lack availability to do work Unscrupulous Financially unstable
Community opposition Infighting & acrimonious relationships Unrealistically low bid Late-stage design changes Unexpected subsurface conditions
Late materials delivery Lawsuits Labor difficulties Unexpected manufacturing costs Failure to find sufficient tenants
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
Outline
Risk and Uncertainty Risk Preferences, Attitude and Premiums Examples of simple decision trees Decision trees for analysis Flexibility and real options
Decision modeling
Decision making under uncertainty Tool: Decision tree
Fault trees
Represent
Flow of time Decisions Uncertainties (via events) Consequences (deterministic or stochastic)
Time
Risk Preference
dislike losing $x far more than gaining $x value gaining $x far more than they disvalue losing $x.
Individuals differ in comfort with uncertainty based on circumstances and preferences Risk averse individuals will pay risk premiums to avoid uncertainty
Risk preference
Decision Rules
maximize the minimum gain (if outcome = payoff) or minimize the maximum loss (if outcome = loss, risk)
The risklover seeks to maximize the maximum gain Max ( min + (1- ) max) , 0 1
repair
$0.55 $1.43
Investment PV
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!
Investment PV
Data link
attitude
Other criteria
For each policy option we select the outcome with the highest probability
Buy later
Buy later
0. 5 0.25 0.25
When individuals are faced with uncertainty they make choices as is they are maximizing a given criterion: the expected utility.
Expected utility is a measure of the individual's implicit preference, for each policy in the risk environment. It is represented by a numerical value associated with each monetary gain or loss in order to indicate the utility of these monetary values to the decision-maker.
1 .7
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) = = .5*0.7 + .25*1.05 + .25*1.35 = ~0.95 Certainty value = -102.5*0.975 = -97.38
125
100
65
Suppose to be awarded a $100M contract price Early estimated cost $70M What is the preference function of cost?
utility
70
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 Lower returns from less risky investments Money paid to ensure flexibility as guard against risk
The risk averter buys a future contract that allow to buy at $ 97.38 The trading company (risk lover) will take advantage/disadvantage of future benefit/loss
Consider a risk averse individual with preference fn f faced with an investment c that provides
.50 .25
This individual would be willing to trade for a sure investment yielding satisfaction>.25 instead
Therefore this person should be willing to trade this investment for a sure amount of money>$5000
$5000
The risk averse individual would be willing to trade the uncertain investment c for any certain return which is > $5000 Equivalently, the risk averse individual would be willing to pay another party an amount r up to $5000 =$10000-$5000 for other less risk averse party to guarantee $10,000
Assuming the other party is not risk averse, that party wins because gain r on average The risk averse individual wins b/c more satisfied
Certainty Equivalent
Note: E[X] is the mean (expected value) operator The mean outcome of uncertain investment c is E[c]
In example, this was .5*$20,000+.5*$0=$10,000 In example, this was .5*f($20,000)+.5*f($0)=.25 Size of sure return that would give the same satisfaction as c In example, was f-1(.25)=f-1(.5*20,000+.5*0)=$5,000
The shapes of the preference functions means can classify risk attitude by comparing the certainty equivalent and expected value
For risk neutral individuals, f-1(E[f(c)])=E[c] For risk averse individuals, f-1(E[f(c)])<E[c]
Consider
Risk averse individual A for whom f-1(E[f(c)])<E[c] Less risk averse party B
A can lessen the effects of risk by paying a risk premium r of up to E[c]-f-1(E[f(c)]) to B in return for a guarantee of E[c] income
The risk premium shifts the risk to B The net investment gain for A is E[c]-r, but A is more satisfied because E[c] r > f-1(E[f(c)]) B gets average monetary gain of r
Preference function f(-1)=0, f(1)=100 Certainty eq. f-1(E[f(c)]) = 0 No help from risk analysis !!!!!
Terminal nodes on decision trees can capture these factors but still need to make different attributes comparable
Pareto Optimality
Even if we cannot directly weigh one attribute vs. another, we can rank some consequences Can rule out decisions giving consequences that are inferior with respect to all attributes
Key concept here: May not be able to identify best decisions, but we can rule out obviously bad A decision is Pareto optimal (or efficient solution) if it is not dominated by any other decision
03/06/06 - Preliminaries
Announcements
Phase 2 due March 17th Phase 3 detailed description posted on Stellar, due May 11 Decision making under uncertainty
Reading questions/comments?
Utility and risk attitude You can manage construction risks Risk management and insurances - Recommended
Bidding
What choices do we have? How does the chance of winning vary with our bidding price? How does our profit vary with our bidding price if we win?
Decisions
Events
Arrival time (On time, early, late) Theft or damage (only if arrive early)
Consequences: Cost
Procurement Tree
Monte Carlo simulation randomly generates values for uncertain variables over and over to simulate a model. It's used with the variables that have a known range of values but an uncertain value for any particular time or event. For each uncertain variable, you define the possible values with a probability distribution. Distribution types include:
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
Optimal Strategy
Delaying decision Extra time Cost to pay for extra fat to allow for flexibility
Alternative Delivery Clear spanning (to allow movable walls) Extra utility conduits (electricity, phone,) Larger footings & columns Broader foundation Alternative heating/electrical
Additional elevator Larger electrical panels Property for expansion Sequential construction Wiring to rooms
Adaptive Strategies
An adaptive strategy is one that changes the course of action based on what is observed i.e. one that has flexibility
Rather than planning statically up front, explicitly plan to adapt as events unfold Typically we delay a decision into the future
Real Options
Key insight: NPV does not work well with uncertain costs/revenues
Considerations
Tradeoffs
Overlapping design & construction and different construction activities limits changes E.g. value engineering away flexibility Selection of low bidder Late decisions can mean greater costs
NB: both budget & schedule may ultimately be better off w/greater flexibility!
Readings
Required
More information:
Recommended:
Meredith Textbook, Chapter 4 Prj Organization Risk management and insurances Stellar
Haimes, Risk modeling, assessment, and management Mun, Applied risk analysis : moving beyond uncertainty Flyvbjerg, Mega-projects and risk Chapman, Managing project risk and uncertainty : a constructively simple approach to decision making