Vahdatmanesh, M and Firouzi, A (2020) Construction material supply risk management using Asian option contracts: The case of a pipeline project. Engineering, Construction and Architectural Management, 27(10), pp. 3395-3414. ISSN 0969-9988
Abstract
Purpose: Steel price uncertainty exposes pipeline projects that are inherently capital intensive to the risk of cost overruns. The current study proposes a hedging methodology for tackling steel pipeline price risk by deploying Asian option contracts that address the shortcomings of current risk mitigation strategies. Design/methodology/approach: A stepwise methodology is introduced, which uses a closed-form formula as an Asian option valuation method for calculating this total expenditure. The scenario analysis of three price trends examines whether or not the approach is beneficial to users. The sensitivity analysis then has been conducted using the financial option Greeks to assess the effects of changes in volatility in the total price of the option contracts. The total price of the Asian options was then compared with those of the European and American options. Findings: The results demonstrate that the Asian option expenditure was about 1.87% of the total cost of the case study project. The scenario analysis revealed that, except for when the price followed a continuous downward pattern, the use of this type of financial instrument is a practical approach for steel pipeline price risk management. Practical implications: This approach is founded on a well-established financial options theory and elucidates how pipeline project participants can deploy Asian option contracts to safeguard against steel price fluctuations in practice. Originality/value: Although the literature exists about the theory and application of financial derivative instruments for risk management in other sectors, their application to the construction industry is infrequent. In the proposed methodology, all participants involved in fixed price pipeline projects readily surmount the risk of exposure to material price fluctuations.
| Item Type: | Article |
|---|---|
| Uncontrolled Keywords: | asian options; pipeline projects; price risk; supply management |
| Index terms: | option, construction industry, risk management, scenario analysis, construction material, cost overrun, case study, pipeline, valuation method, exposure, risk mitigation, methodology, strategy, pipeline construction, sensitivity analysis |
| Subjects: | decision analysis, industry analysis, infrastructure and transport systems, environmental hazards, management, public and environmental health, research methods, civil engineering, financial risk, building materials, real estate economics, financial and cost management, data collection methods, risk assessment, policy studies |
| Topics: | Urban Studies, Health and Safety, Business Strategy, Cost Management, Engineering Principles, Research Practice, Risk Management, Governance, Sustainability |
| Descriptive scope: | 5 PCTEA |
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