New Research Directions in Engineering Economics—Modeling Dependencies with Copulas

Understanding and quantifying dependencies among variables often arises in stochastic capital investment and real option analysis. In such modeling situations, Pearson product moment linear correlation is widely used as a dependence measure. Linear correlation has several limitations. More recently, copulas have been used in financial economics and insurance to model dependencies. We contribute to the engineering economy literature by introducing copulas to model dependent risks that will enhance research and practice. We demonstrate the usefulness of copula-based sampling in simulation of project risk and regression analysis for forecasting. We also discuss potential copula research in engineering economic analysis.     

Postauditing and Cost Estimation Applications: An Illustration of MCMC Simulation for Bayesian Regression Analysis

Often in Bayesian anlysis closed-form posteriors cannot be derived for complex models. However, it is important to be able to do Bayesian analysis relatively easily. This article presents an alternative, the more general Markov chain Monte Carlo (MCMC) simulation approach, which permits the efficient development of posterior distributions. MCMC simulation methods are now becoming the state of the art in numerous empirical and analytical applications in applied mathematics, biostatistics, marketing, economics, and other areas, but those methods are noticeably absent in the engineering economic analysis literature. The purpose of this article is to introduce MCMC simulation methods to the engineering economics research and practitioner community. Using postaudits and cost estimation as application areas, the article focuses on what MCMC simulation entails, its advantages, and its disadvantages and highlights the usefulness and versatility of the approach.     

Learning from foreign investment by rival firms: Theory and evidence

We offer an alternative explanation for follow-the-leader behavior in foreign investment decisions based on Bayesian learning by rival firms. We test the implications of the model through a panel count data sample of MNEs that have invested in Central and Eastern Europe over the period 1990–1997. Interacting the measure of rivals' investment in country-industry pairs with uncertainty, we are able to identify the channel of Bayesian learning about revenue postulated by the model as the only one consistently generating the detected follow-the-leader behavior of foreign investments. The empirical findings are robust with respect to different model specifications.     

Optimizing the number of industrial salespersons

The objective of this article is to examine the major alternative methods currently used for optimizing the industrial sales force size and to assess their applicability in industrial firms. The article examines in detail the main difficulties facing an industrial firm trying to optimize its sales force, discussing some of the factors that affect industrial selling strategy and policy. The five alternative major techniques for optimizing the number of industrial salespersons, are then discussed in detail, presenting the basis of each approach/method, its advantages and disadvantages for an industrial firm, and when the method is applicable in an industrial marketing situation.     

On whether to prosecute suspected price-fixing conspi racies: A hypothesis-testing approach

This paper analyses the antitrust policy decision of whether to sue prosecute a suspected price-fixing cartel. The analysis is conducted in the Bayesian hypothesis-testing mode, using a Cournot market. framework. This approach recognizes that the decisions to instilute an investigation, file suit, or go to trial, are all binary decisions that involve testing a null hypothesis: notably. the hypothesis that the antitrust laws have not been violated versus the alternative hypothesis that they have been violated. Rejecting the null hypothesis is equivalent to electing to proceed along the prosecution path. The paper demonstrates that formalization of the decision-making process can help to enhance our understanding of the factors that underlie the various decisions, and particularly how those factors can influence the decisions, and provides guldellnes for antllrust administration under the current U. S. antitrusl laws.     

Dual Kriging: An Exploratory Use in Economic Metamodeling

Sensitivity analysis of capital investments can be effectively carried out by employing a metamodel approach and experimental designs. Although polynomial regression metamodels are popular and straightforward, they do not consider spatial relationships among the data. Dual kriging is an estimation technique that allows the incorporation of spatial correlation into the interpolation or estimation process and has been used primarily in geophysical statistical analysis. This article investigates the dual kriging approach as an alternative technique to polynomial regression and artificial neural networks for metamodel analysis of capital investments. It is observed that dual kriging shows potential in performing sensitivity analysis as its accuracy is as good as, or better than, other techniques, and, while model building and interpretation is more complicated than that of polynomial regression, it is significantly more straightforward than that of neural networks. Furthermore, this is the first known work of using kriging in the field of engineering economics; there may be other useful applications such as in cost estimation.     

A Review of“BUSINESS INVESTMENT POLICY”* A Critical Review GEORGE TERBORGH: Machinery and Allied Products Institute and Council for Technological Advancement, 1200 Eighteenth Street,N.W., Washington,D.C., 1958. 260 pp. $6 (A MAPI Study and Manual)

In my previous article on “Project Justification in a Multi-product Chemical Plant”, which appeared in the Fall 1959 issue of The Engineering Economist, I discussed the underlying causes for equipment acquisition and replacement in the chemical industry, and followed with a presentation of the payout-time technique for evaluating capital expenditure, as designed by a leading dye and pharmaceutical plant. Many other well-known techniques, such as the Annual Cost method, the Discounted Cash Flow, and the MAPI approach, are also available to management. However, none of the techniques mentioned relieves management of the basic responsibility for making the ultimate decisions regarding capital acquisition for expansion or replacement. The methods do present management with an analysis pointing up the relative merits of a given type of investment, and give some indication as to which alternative is the more desirable. Management, nevertheless, must assume responsibility for the final decision.     

Letter From the Editor

This paper Identifies situations in which the widely recommended procedures for evaluating mutually exclusive projects with unequal lives may result in incorrect project rankings. These situations arise from the failure of conventional techniques to place alternatives on an appropriate equivalent-risk basis and may occur whether a net present value or equivalent annual annuity approach is utilized. We develop alternative discounted cash flow procedures which correctly reflect the nature of risk. In so doing, we address the following important issues: 1) the choice of the discount rate to be used in calculating the net present value of a series of replications of a project: 2) the choice of a discount rate for calculating the equivalent annual annuity for a series of replications: and 3) the selection of an appropriate common-life horizon for comparison of alternative projects.     

Morphological analysis in agricultural R&D: A technologist's approach to the definition and economic evaluation of technologies

The research scientist, the planner, and the R&D manager require a methodology that can compose a wide range of technological options within a realistic production system context and subject these options to a comprehensive, multi-parameter economic analysis. A technologically-oriented approach to the generation and ex-ante assessment of technologies is developed for this purpose in an agricultural R&D context. The approach is based on morphological analysis, in which a production process is defined as a series of tasks each of which can be accomplished by one or more alternative techniques. The model is customized for any specific production system using information provided by technology experts. This information is received in the language of the technologist, structured in a way that promotes an holistic view of the system, and processed to answer the needs of the economic evaluator. The model has been well received by technologists in the analysis of about a dozen diverse R&D projects.     

Using Bayesian methods in strategy research: an extension of Hansenet al.

Hansen, Perry, and Reese ( 2004 ) recently argued for and demonstrated the utility of Bayesian methods for research associated with the resource‐based view (RBV) of the firm. In this paper, we propose that Bayesian approaches are highly relevant not only for strategy problems based on the RBV, but also to its extensions in the areas of dynamic capabilities and co‐evolution of industries and firms. Further, we argue that Bayesian methods are equally applicable for a wide range of strategy research questions at both the micro‐ and macro‐level. Bayesian techniques are especially useful in addressing specific methodological challenges related to firm‐ and individual‐level effects, firm‐level predictive results, precision with small samples, asymmetric distributions, and the treatment of missing data. Moreover, Bayesian methods readily permit the engineering and updating of more realistic, complex models. We provide a specific illustration of the utility of Bayesian approaches in strategy research on entry order and pioneering advantage to show how they can help to inform research that integrates micro‐ and macro‐phenomena within a dynamic and interactive environment. Copyright © 2006 John Wiley & Sons, Ltd.     

Assessing the risks of service failures based on ripple effects: A Bayesian network approach

This study responds to the need for assessing risks of service failures by focusing on ripple effects. We propose a Bayesian network approach to assessing risks of service failures based on the depdendence relationships among individual service failures. To avoid conceptual misunderstanding and imprecise use in practice, the suggested approach is designed to be executed in three consecutive stages: modeling a Bayesian network; assessing the risks in terms of probabilities of service failures (PSFs) and impacts of service failures (ISFs); and developing a service failure assessment map. A case study of the outpatient consultation service is presented to show the feasibility of our method.     

The Internal Rate of Return Approach and the AIRR Paradigm: A Refutation and a Corroboration

This article shows that the internal rate of return (IRR) approach is unreliable and that the recently introduced average internal rate of return (AIRR) model constitutes the basis for an alternative theoretical paradigm of rate of return. To this end, we divide the paper into two parts: a pars destruens and a pars construens. In the “destructive” part, we present a compendium of 18 flaws associated with the IRR approach. In the “constructive” part, we construct the alternative approach from four (independent) economic intuitions and put the paradigm to the test by showing that it does not suffer from any of the flaws previously investigated. We also show how the IRR, as a rate of return, is absorbed into the new approach.     

An alternative approach to allocate universal service obligations

In a liberalized telecommunications market universal service is considered to be essential for social life of each member of society. However, to avoid discrimination the universal service provider has to be compensated for universal service costs. Instead of calculating universal service costs directly, someone may take auctions as an alternative approach to allocate universal service obligations. In this case the compensation as well as the universal service provider is implicitly determined by the bids of the participants of the auction. In this paper we scrutinize whether this is an appropriate approach.     

Predicting Spatial Patterns of House Prices Using LPR and Bayesian Smoothing

This article is motivated by the limited ability of standard hedonic price equations to deal with spatial variation in house prices. Spatial patterns of house prices can be viewed as the sum of many causal factors: Access to the central business district is associated with a house price gradient; access to decentralized employment subcenters causes more localized changes in house prices; in addition, neighborhood amenities (and disamenities) can cause house prices to change rapidly over relatively short distances. Spatial prediction (e.g., for an automated valuation system) requires models that can deal with all of these sources of spatial variation. We propose to accommodate these factors using a standard hedonic framework but incoporating a semiparametric model with structure in the residuals modeled with a partially Bayesian approach. The Bayesian framework enables us to provide complete inference in the form of a posterior distribution for each model parameter. Our model allows prediction at sampled or unsampled locations as well as prediction interval estimates. The nonparametric part of our model allows sufficient flexibility to find substantial spatial variation in house values. The parameters of the kriging model provide further insights into spatial patterns. Out–of–sample mean squared error and related statistics validate the proposed methods and justify their use for spatial prediction of house values.     

A Simple Bayesian Procedure for Sample Size Determination in an Audit of Property Value Appraisals

The article proposes a simple Bayesian technique for auditing property appraisals to determine whether state accuracy guidelines are met. The proposed technique addresses elicitation of appraisers' prior beliefs, computation of reappraisal sample sizes and reporting of audit results. To facilitate communication of quantitative audit findings to nonstatistician stakeholders, the concept of variance appears nowhere in prior elicitation or reporting. In contrast to classical frequentist techniques, the Bayesian procedure easily integrates expert judgment and responds flexibly to the arrival of new information. In addition, the Bayesian procedure significantly reduces the number of reappraisals required to regulate appraisal systems when they are functioning well. The technique can be applied in other settings where government officials audit their own work and must convince overseers, especially the public, that accuracy requirements are satisfied.     

Repeat Sales as a Matching Estimator

The most common approaches for constructing house price indices—hedonic price functions and the repeat sales estimator—focus on changes over time in mean prices. Though the hedonic approach is less wasteful of data than the repeat sales estimator, it relies on an accurate specification of the underlying econometric model. I suggest using a matching estimator as an alternative to the hedonic and repeat sales approaches. Like the repeat sales approach, a matching estimator uses pairs of sales from different dates to estimate the mean difference in sales prices over time. The matching approach preserves much larger sample sizes than the repeat sales estimator while requiring less preimposed structure than the hedonic approach. The matching approach makes it easy to characterize changes in the full distribution of house prices.     

Product-based planning: the importance of project and project management deliverables in the management of clinical trials

As the cost of clinical trials continues to rise organisations are looking at ways of managing this part of the drug development process as effectively and efficiently as possible. As a tactical response, many pharmaceutical companies outsource the management of clinical trials to clinical research organisations on a fixed-price contract basis. This paper presents an alternative approach based on the concept of Product-Based Planning. Key elements of the approach are the creation of a deliverables budget and the establishment of project management-related deliverables. The conceptual developments described in the paper are supported by a telephone survey of 10 UK practitioners. The survey confirms the prevalence and limitations of fixed-price contracts while highlighting a willingness to try a deliverable-based approach – initially through small pilot studies. The key barrier to implementing a new approach is resistance from key stakeholders, such as finance departments, which can be addressed through selling of the business case.     

A radical constructivist approach to boundaries in business network research

We contribute to the business network literature by presenting and introducing a radical constructivist research approach, in which we foreground sharing the context of an actor's understanding of interaction. We elaborate the approach by illuminating the problematic issue of boundaries in business network research. We conceptualize boundaries as inter-action spaces and times where differences are created, maintained and changed in a physical-social setting. We make a distinction between boundaries and borders, with the latter being simply representations. We undertake a review of select realist and social constructivist business network literature to distinguish and elaborate the potential of a radical constructivist perspective, as an alternative approach. The approach appears most useful when the researcher and interview participant do not have a convergent understanding of the research phenomenon. Further, a radical constructivist approach is eminently suitable for settings where inter-action conditions and content are changing, for example in times of crisis or network change. We present the metaphors of castles and frontiers, as illustrative research tools suitable for a radical constructivist study of boundaries in business networks.     

Privately Versus Publicly Held Asset Investment Performance

Classic asset pricing is problematic as a method to assess privately held asset investment performance. We propose an alternative approach that involves adjusting the characteristics of assets constituting an index or portfolio to match the asset characteristics of a reference index or portfolio. This approach is applied to commercial real estate, where we create an index of REIT returns to compare to the NCREIF index. To enhance comparability, return indices are adjusted for partial-year financial data, leverage, asset mix and fees. Adjusted results over a 1980–1998 sample period show general convergence between the indices, although an annual return difference of over three percentage points remains in favor of public market asset ownership. Possible causes of the investment performance gap include liquidity and geography as missing risk factor adjustments, an unrepresentative sample period, and the form in which commercial real estate assets are held.     

Beyond `The Design Process': An Alternative Pedagogy for Technology Education

`The design process' as an underpinning structure for technology education is well established. A number of increasingly complex models have been produced to describe the design process. These models have had a widespread, paradigmatic effect on the teaching of technology education. The development and implementation of models of the design process and the influence of these on teacher's classroom practice is examined, and it is then argued that the paradigm is fatally flawed, and that continued adherence to it is having a detrimental impact on children's learning in technology. It is suggested that the basis of an alternative pedagogy for technology education already exists within the research literature. Two examples of an alternative approach for teaching technology are described, and some practical limitations outlined. This revised version was published online in July 2006 with corrections to the Cover Date.