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Contingency estimation using a real options approach

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  • Chung-Li Tseng
  • Tong Zhao
  • Chung Fu

Abstract

In construction projects, contingency is the budget which is made available to cope with uncertainties that would incur schedule and cost overruns. Contingency estimation requires considering project cost, schedule and technology variability. The effect of dynamic project management of the decision maker should also be taken into account. Accordingly a real options approach for estimating contingency from the owner's point of view is presented. This approach not only explicitly recognizes the uncertainty in the life cycle of a construction project, but also incorporates a dynamic project management mechanism into contingency estimation. The contingency is valued by minimizing the expected project cost via a multi-stage stochastic model that accounts for the variability of project cost and schedule and the exercise of dynamic project crashing. The numerical results indicate that the value of the decision maker's dynamic project management makes up an important portion of the contingency.

Suggested Citation

  • Chung-Li Tseng & Tong Zhao & Chung Fu, 2009. "Contingency estimation using a real options approach," Construction Management and Economics, Taylor & Francis Journals, vol. 27(11), pages 1073-1087.
    • Handle: RePEc:taf:conmgt:v:27:y:2009:i:11:p:1073-1087
    DOI: 10.1080/01446190903222411
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    References listed on IDEAS

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    Cited by:

    1. Carlos Jesus Gonzalez Macias, 2015. "Organizational Fit From A Contingency Theory And Configuration School View La Adaptabilidad Organizacional Desde El Enfoque De La Teoria De Contingencia Y La Escuela De Configuracion," Revista Global de Negocios, The Institute for Business and Finance Research, vol. 3(4), pages 69-81.
    2. Kwabena Mintah, 2018. "Real Options Analysis in Residential Property Development Decision-Making in Australia: Perspective of Executives," International Real Estate Review, Global Social Science Institute, vol. 21(4), pages 473-520.
    3. João Adelino Ribeiro & Paulo Jorge Pereira & Elísio Brandão, 2012. "Reaching an Optimal Mark-Up Bid through the Valuation of the Option to Sign the Contract by the Successful Bidder," CEF.UP Working Papers 1201, Universidade do Porto, Faculdade de Economia do Porto.

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