Optimism bias, risk and sensitivity analysis

2.16 When conducting appraisal consideration should also be given to:

  optimism bias - this is the proven tendency for appraisers to be too optimistic about key project parameters, including capital costs, operating costs, project duration and benefits delivery. Over-optimistic estimates can lock in undeliverable targets and it is therefore critical to make adjustments for this. The Green Book recommends applying specific adjustments for optimism bias. Cost estimates are increased by a set percentage to reflect evidence of underestimation from previous similar interventions. Adjustments should be based on an organisation's own evidence base for historic levels of optimism bias. In the absence of this, generic values are provided.

  risks - these are specific uncertainties that arise in the design, planning and implementation of an intervention. Risk costs are the costs of risks materialising, avoiding risks, sharing risks and mitigating risks, estimated on an expected likelihood basis. Policy makers need to ensure these risks are fully understood and managed, including low probability but high impact events.

  sensitivity analysis - involves exploring the sensitivity of expected outcomes of an intervention to potential changes in key input variables. Switching values can be estimated as part of sensitivity analysis where appropriate. These are the values an input would need to change to in order to make an option no longer viable.