A Framework for Understanding and Modeling Risk in Mega-Projects and Its Impact on the Markets for Project Finance

Abstract

The authors detail an approach to characterizing the risk of large projects from the perspective of the project finance markets. Unlike current statistical and correlation-based mechanisms of risk characterization, this article evaluates the dynamic nature of complexity in large projects based on causality and explores its relation to risk. The authors suggest a framework to understand and model complexity and risk so as to distill it into components, their interactions, and their impact on access to project finance and risk premiums. They argue that the adoption of such a framework can have a transformative impact on mega-projects and the markets for project finance and suggest how innovations in project finance can be accelerated using their framework. They believe that infrastructure projects, the project finance industry, banks, institutional investors, mega-project sponsors, governments, and multi-lateral agencies will benefit from such a framework. By being able to model, measure, and monitor mega-project dynamic risk characterization, these institutions will be able to structure, organize, and finance projects effectively on an ongoing basis. This, the authors think, will eventually expand the market by increasing the number of participants, leading to enhanced market liquidity and an opportunity for expansion in functional project finance markets.