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A macro approach to estimating correlated random variables in engineering production projects

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  • David Hudak
  • Mark Maxwell

Abstract

An important consideration in cost risk analysis is the amount of correlation between different cost elements. If correlation is ignored, both the probability and magnitude of costs overruns could be significantly underestimated. The two major difficulties in implementing correlation addressed are estimating correlation coefficients and providing an accurate theoretical risk analysis approach to account for these correlations. Since detailed correlation data are often difficult or impossible to obtain, an intuitive approach is proposed, which estimates correlations for cost estimates relative to several underlying macro factors. The correlation matrix obtained by this method is positive semi-definite and a case study based upon three macro factors is given. The cost risk distributions are computed and compared using the beta fit model and two other more complicated models. This study shows negligible differences in cost risk dollars when computed by the various models. This method of using macro factors to estimate correlation coefficients can account for significant additional cost risk dollars while not requiring external correlation data.

Suggested Citation

  • David Hudak & Mark Maxwell, 2007. "A macro approach to estimating correlated random variables in engineering production projects," Construction Management and Economics, Taylor & Francis Journals, vol. 25(8), pages 883-892.
    • Handle: RePEc:taf:conmgt:v:25:y:2007:i:8:p:883-892
    DOI: 10.1080/01446190701411224
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    References listed on IDEAS

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    1. Allen Fleishman, 1978. "A method for simulating non-normal distributions," Psychometrika, Springer;The Psychometric Society, vol. 43(4), pages 521-532, December.
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    3. Philip M. Lurie & Matthew S. Goldberg, 1998. "An Approximate Method for Sampling Correlated Random Variables from Partially-Specified Distributions," Management Science, INFORMS, vol. 44(2), pages 203-218, February.
    4. Malik Ranasinghe, 2000. "Impact of correlation and induced correlation on the estimation of project cost of buildings," Construction Management and Economics, Taylor & Francis Journals, vol. 18(4), pages 395-406.
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