ALARP Criteria to Estimate Acceptability and Tolerability Thresholds of the Investment Risk

Abstract

Assessing the riskiness of investments in civil works is an integral part of the decision-making process. The main limitation is the absence, both in the regulatory landscape and in the literature of the sector, of threshold values that can guide the analyst in expressing an assessment on the acceptance of the investment risk. The aim of the paper is to define a risk management model that overcomes this gap by introducing acceptability and tolerability thresholds for project risk. The idea is to jointly use: (i) the As Low As Reasonably Practicable (ALARP) logic, from which the concepts threshold of acceptability and tolerability of risk derive, for the first time applied to assess the project risk in the civil field; (ii) the Capital Asset Pricing Model (CAPM) and statistical methods to define an innovative methodology for estimating the aforementioned threshold values. According to the proposed approach, these risk limit values can be specified according to both the investment sector and the socio-economic context of the project. The implementation of the methodology in the civil company sector in Europe allows to validate the described model. The elaborations show that the financial performance of the project is widely acceptable if the Expected Internal Rate of Return is greater than 7.8%; unacceptable if the expected rate of return is less than 5.6%; and tolerable as an ALARP if the expected rate is between 5.6% and 7.8%. The estimated acceptability and tolerability thresholds can provide the economic operator with a more immediate and consistent evaluation of the triangular balance of risks, costs, and benefits. This allows the decision-making process to become more rational and transparent.

Keywords

• Cost-Benefit Analysis (CBA)
• investment risk
• As Low As Reasonably Practicable (ALARP)
• Capital Asset Pricing Model (CAPM)