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The Winner's Curse and Cost Estimation Bias in Pioneer Projects

Quirk, James P. and Terasawa, Katsuaki (1984) The Winner's Curse and Cost Estimation Bias in Pioneer Projects. Social Science Working Paper, 512. California Institute of Technology , Pasadena, CA. (Unpublished) http://resolver.caltech.edu/CaltechAUTHORS:20170920-144446307

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Abstract

Cost overruns are almost as massive and almost as pervasive on private "first of a kind" projects as on defense contracts. This paper examines the cost overrun problem in terms of the methodology of cost estimation, abstracting from moral hazard problems. The main results of the paper are these: first, if cost estimators are an unbiased estimation methodology, then under certain monotonicity conditions, this will produce an observed cost underestimation bias, because cost estimates are used as a guide to project decision making; second, the more uncertainty there is with respect to the costs of a project, the larger will be the observed cost underestimation bias, assuming the estimator uses an unbiased estimation methodology; third, in bottoms up estimation, the most accurate of cost estimation methodologies, there is a built in cost underestimation bias because the value of information is not incorporated into the cost estimate; fourth, the size of the underestimation bias in bottoms up estimation definitely-increases with uncertainty only under rather stringent conditions on the construction production function.


Item Type:Report or Paper (Working Paper)
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http://resolver.caltech.edu/CaltechAUTHORS:20171114-141649753Related ItemPublished Version
Additional Information:Revised. Original dated to February 1984. This work was performed by the Arroyo Center of the Jet Propulsion Laboratory, which conducts research for the United States Army through agreement with the National Aeronautics and Space Administration. The views expressed in this paper are those of the authors, and do not necessarily represent the views of the Arroyo Center JPL, NASA or the U. S. Army. We would like to thank Kenneth Arrow, Dave Grether, Linda Cohen, Jennifer Reinganum and Louis Wilde for comments on an earlier version of this paper. Earlier work on this topic was funded by a grant from Exxon at the Environmental Quality Laboratory at Caltech. Published in Land Economics, V. 62, #2, May 1986, pp. 192-200.
Group:Social Science Working Papers
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Funding AgencyGrant Number
ExxonUNSPECIFIED
Subject Keywords:Cost Estimation Bias
Classification Code:JEL: 026, 114, 512
Record Number:CaltechAUTHORS:20170920-144446307
Persistent URL:http://resolver.caltech.edu/CaltechAUTHORS:20170920-144446307
Usage Policy:No commercial reproduction, distribution, display or performance rights in this work are provided.
ID Code:81636
Collection:CaltechAUTHORS
Deposited By: Jacquelyn Bussone
Deposited On:20 Sep 2017 22:11
Last Modified:15 Nov 2017 23:20

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