(DP 2000-13) Using Monte Carlo Simulation in a System for Project Risk Appraisal: Options for Government and Private Practitioners

Abstract

This study is an offshoot of a project on the estimation of contigent liabilities of the Philippine government. The Monte Carlo simulation method adopted for estimating exposure (or expected losses) to NG-assumed risks in many Build-Operate-Transfer infrastructure projects makes it possible for policymakers to classify and rank projects according to risk, and set risk-adjusted guarantee fees, helping to mitigate many adverse selection and moral hazard problems in the project appraisal, approval, and monitoring process. Six projects (not explicitly identified) are analyzed for risk, and risk indicators are constructed for each to facilitate comparison and classification. Projects for which government bears excessive risk may be restructured before approval, while contigency financing may be arranged for projects that have already commenced operations. In addition, expected lesses serve as an input into the calculation of actuarially-fair guarantee premia.