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Collar Option Model for Managing the Cost Overrun Caused by Change Orders

Author

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  • Sanghyo Lee

    (Institute of Occupational Medicine, Social Medicine and Environmental Medicine, Goethe-University, Theodor-Stern-Kai 7, Haus 9b, Frankfurt am Main 60590, Germany
    Sustainable Building Research Center, Hanyang University, 55 Hanyangdaehak-ro, Sangrok-gu, Ansan-si, Gyeonggi-do 426-791, Korea)

  • Kyunghwan Kim

    (Department of Architectural Engineering, Konkuk University, 120 Neungdong-ro, Gwangjin-gu, Seoul 143-701, Korea)

Abstract

Effective change order management is very important in maintaining the financial sustainability of various stakeholders related to construction projects by minimizing cost overruns. In this study, we propose a zero-cost risk management approach based on the collar option model in order to control for the loss caused by change orders, the main cause of cost overruns in construction projects. We apply this model to actual projects for empirical analysis. The analysis, based on 237 projects, indicates that insurance buyers benefit from the collar option model in 46% of the cases, while insurance sellers do so in 53% of the cases. In most cases, the insurance buyer is the owner. According to the model, the owner experiences a loss when the cost overrun caused by change orders is lower than what was expected. In such cases, it is appropriate to conclude that the loss is not caused by the collar option model, but by the absence of additional revenue. However, the insurance seller suffers a loss if the cost overrun is higher than the strike price of the call option. Thus, the insurance seller needs to have expertise in construction management.

Suggested Citation

  • Sanghyo Lee & Kyunghwan Kim, 2015. "Collar Option Model for Managing the Cost Overrun Caused by Change Orders," Sustainability, MDPI, vol. 7(8), pages 1-15, August.
    • Handle: RePEc:gam:jsusta:v:7:y:2015:i:8:p:10649-10663:d:53871
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    References listed on IDEAS

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    Cited by:

    1. Amadi Alolote, 2019. "Towards Critical Realism in Cost Overrun Research," International Journal of Innovation and Economic Development, Inovatus Services Ltd., vol. 4(6), pages 23-31, February.
    2. Fernandes, Gláucia & Gomes, Leonardo & Vasconcelos, Gabriel & Brandão, Luiz, 2016. "Mitigating wind exposure with zero-cost collar insurance," Renewable Energy, Elsevier, vol. 99(C), pages 336-346.
    3. Riko Hendrawan, 2023. "Comparison of Black-Scholes and GARCH Option Models on The Jakarta Islamic Index with Collar Strategy," GATR Journals jfbr209, Global Academy of Training and Research (GATR) Enterprise.
    4. Jarosław Górecki & Manuel Díaz-Madroñero, 2020. "Who Risks and Wins?—Simulated Cost Variance in Sustainable Construction Projects," Sustainability, MDPI, vol. 12(8), pages 1-31, April.

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