For cost–benefit analyses (CBA) of public-sector projects, a common misconception is that the discount rate should include a risk premium in consonance with the private-sector practice of doing so. In examining the issue, this report addresses different types of risk separately: 1. downside risk, which arises from optimistic bias in forecasts; and 2. pure risk, which is the variation remaining around the mean after removing downside biases The report’s conclusion that pure risk can reasonably be ignored in most situations has implications for risk management. Alternative risk management strategies can be compared using the state-contingent approach to find the one that yields the highest expected net present value (NPV). Downside risk is part of a wider problem called ‘optimism bias’. Besides the simple failure to consider what can go wrong, there are political–institutional factors that give project proponents incentives to overstate the positives and understate the negatives. (a)
Samenvatting