Completion Risks
While completion insurance for construction projects is not a new business, for certain high-profile projects I wonder if it wouldn’t make sense to open up the risk pricing to a wider audience…
The recently unveiled plans for the London 2012 Olympic stadium got me thinking about this (from London Metro:)
The £496m structure, which has jumped in price from the £280m estimated in 2004 when London was bidding for the Games, will stand at the heart of the Olympic Park. It is being billed as a design representing a new era for Olympic stadium design.
Building work on the stadium is set to begin up to three months ahead of schedule in April or May, with completion in 2011 to allow for test events, the Olympic Delivery Authority (ODA) said.
I suspect that if you had a market in construction cost and completion date, both would go bid very quickly at £496mn and May 2011…and it would be a good bet. As Mr Taleb drives home in Black Swans, the people responsible for making these forecasts at best include all the normal - ‘expected’ - factors that contribute to the cost and delivery date of the development. It is unlikely that they have accounted for things outside those which have historically contributed to delays and cost overruns. Indeed, there is no way of “scientifically” accounting for these possibilities, and I further suspect if they were to add an arbitrary 50% or more haircut to at least provision for some unknown eventuality, they would never be allowed to do so (by the customer, the accountants, the insurers, etc.) However if there was a traded market price any interested party would be able to hedge this risk. This is not to say “the crowd is wise” and can know the unknowable (as is the often mistaken cry of prediction market evangelists) but that with a traded market the risk is better syndicated (distributed) to those best able to bear it at any given price. And the price signals - while not omniscient - would be useful to both the customer (London 2012) and the construction companies. For unlike the Syndey Opera house, the deadline is hard. (Well there is always Wembley I guess if it all goes completely pear-shaped…)
So I guess I should send a request over to Betfair to get these markets up and running! Only problem is (and this is why the future lies is data - robust, clean, reproduceable data) you would need to have a clear and robust settlement mechanism. Probably easier for delivery date (esp. if market settles on a week, fortnight or month to avoid ribbon cutting date shenanigans - ie insider trading) than for cost. That said given that it is a public project there must be some government auditing department that could state the methodology and vouch for the accuracy of the final accounting.
November 9th, 2007 at 3:14 pm
[…] This blog post at The Park Paradigm makes me remember that I’ve always been bullish about prediction markets on architectural project delivery date. I believe that that’s an instance where insider information can beat the project manager’s bullyness. […]
November 9th, 2007 at 6:06 pm
Hello, Sean. My name is Jed Christiansen, and I run a consulting practice that helps companies implement prediction markets.
While there are certainly a few wild claims out there on prediction markets, there’s really only one gold standard. Prediction Markets CAN’T know the “unknowable,” but they aggregate the current knowledge better than virtually any other system. This means that prediction markets may very well NOT do a good job of forecasting a project like the London 2012 stadium, but a prediction market should be more accurate than any expert or other system or algorithm out there.
Regards,
Jed
http://blog.mercury-rac.com
November 12th, 2007 at 1:42 pm
Hi Sean,
I have been keenly following your blog for a while and am astounded by the varied ideas and thoughts on here. As i am starting an MBA in autumn 08, would love to know what books/magazines/articles etc you seek inspiration from. This might sound cheeky but a Park Paradigm reading list would be a fantastic addition to this site.
Best Rgds
Hamzah
November 12th, 2007 at 9:18 pm
Over at Risk, Alexander Campbell has raised a couple good questions wrt the viability of a market in completion risk. In particular he asks who would take the ‘other side’ of a market in completion date? ie Who is at risk if the project is delivered early? A good question, no?
Well yes and no. Clearly one of the biggest obstacles in developing a successful traded market is finding a balance of demand on both sides of the outcome; without this markets are illiquid and generally of little use for risk management. So it is indeed important to understand who and why people might be interested in taking this risk. However, the question I would suggest is framed forgetting that risk and opportunity are the same thing. Firstly by putting a monetary value on different deliver dates would allow contractors to monetize any ability they might have to deliver ahead of time. Secondly, the most likely market to develop liquidity would be a market in “how late” the project will be delivered.
As for the idea that excess costs can usually be passed on to the customer (taxpayers in the case of public works), I would speculate that if markets in delivery price existed on certain projects, it would make budgeting and accountability more robust all around and less likely that contractors could get away with “bait and switch” pricing. At the very least, the customer would have a much better idea how much money the project would really cost and could make sure sufficient funds are available for the expected overrun.
November 12th, 2007 at 9:43 pm
Thanks for your comment Jed - not sure how long you’ve been a reader but you are preaching to the choir: I’ve been a keen supporter of prediction markets for several years although I must admit that I can’t help but poking fun at some of the more zealous elements of this emerging ‘community’… Btw congratulations on the creation of the PMIA. I definitely look forward to following developments on this front.
November 13th, 2007 at 3:09 pm
Hamzah, thanks for your support and good luck with your MBA next year. I have been planning to revamp this site for several months now and including a reading list or link to my librarything (which would mean I would have to populate it!) is indeed one of the things “on the list”, which also includes completely revamping my blog roll to reflect the hundreds of sites I track using netvibes. Maybe just maybe I’ll get around to it before you matriculate! How did you come across my site and in what business are you working now if you don’t mind me asking?