The Portfolio Effect Reconsidered
Management & Lessons Learned Track
It has recently been argued that funding for multiple missions benefits from a portfolio effect – that is, that the various risks of cost overruns for individual missions is less when considered as a group. This is based on modern financial theory that was originally developed by Nobel laureate Harry Markowitz. The result of this diversification, in theory, should allow NASA the ability to fund individual missions at, for example, the 61st percentile, while achieving an overall confidence that is much higher, such as the 80th percentile. However, this convenient and elegant theory ignores the high frequency of large cost overruns. According to a recent cost growth study by NASA Headquarters, 12% of recent NASA projects have experienced cost growth in excess of 100%. This is because reality has “fat tails” that cannot be adequately modeled by the commonly used normal and lognormal distributions. The gap between theory and reality is demonstrated, and potential methods for handling this gap are discussed.
Dr. Christian Smart is employed as a technical manager with MCR, LLC. He is a SCEA Certified Cost Estimator/Analyst and served as President of the Greater Alabama Chapter of SCEA during the 2004-2005 program year. Dr. Smart’s paper “Process-Based Modeling” was awarded best paper in the applications track at the 2004 annual ISPA conference. He was awarded the Huntsville Area Technical Societies’ SCEA Professional of the Year in 2006.
Dr. Smart holds bachelor’s degrees in economics and mathematics from Jacksonville State University, and a Ph.D. in applied mathematics from the University of Alabama in Huntsville.