A practical method of determining project risk contingency budgets

Abstract

Given a collection of accepted risks with corresponding impacts and probabilities over the life of a project (or a relevant portion), a method to estimate the total potential impact at a given certainty is presented. Project sponsors and managers can decide their risk tolerance and set aside corresponding contingency funds. This analytic method uses a binomial distribution with a probability equal to the risks’ average probability. At a desired statistical confidence level, the number of risks to consider is determined, and risks are ranked in descending order of either impact or expected value of impact. The ranked risks’ impacts are then summed over the specified number of risks, leading to an appropriate contingency budget. The budget found with this method compares extremely well with the one ascertained from numerical simulations of the risk occurrences.

Keywords:

• risk
• simulation
• control
• planning
• decision analysis
• project management

Acknowledgements

We thank Professor Theodore Glickman for his careful reading of the text and subsequent constructive suggestions toward its improvement.