The value-at-risk (VAR) with construction item pricing
Date of this Version
The risks caused by the unbalancing of prices assigned to a project’s constituent items has previously also been vaguely acknowledged. A new component unit pricing (CUP) theory has presented a new approach which provides explanation and proof that different distributions of mark-up amongst the items of a project exposes them to different degrees of risk. The risks have now been identified as those of ‘rejection’, ‘reaction’ and of ‘being wrong’. The first two of these risks is described as being ‘direct’ whilst the third one is regarded as ‘indirect’. These two forms are not compatible in the sense that they are not simply additive. Instead, a new measure of risk called value-at-risk (VaR), now widely adopted in financial services, is suggested by which to find a common language for both the direct and indirect risks, such that they can then be assessed similarly and added so as to identify the overall risk being generated by these prices. By being able to assess the risks, the contractor can seek to maximise their utility rather than their profit. The previous method of optimising profit was cause for prices to gravitate to extreme highs or extreme lows, simply because all prices within these set limits were regarded as being without risk whereas any price beyond these extremes was regarded simply as being too risky.
This document has been peer reviewed.