Project correlation in portfolio theory: Fid-Bau Portal

Project correlation in portfolio theory

Eldukair, Z. A. / Ayyub, B. M.

The use of portfolio theory allows the consideration of correlation between projects and may rationalize the selection of the projects and capital budgeting. Positive coefficient of correlation increases the risk for a portfolio, while negative coefficient decreases the risk. On the other hand, the expected return of a portfolio may increase or decrease due to project correlation. The correlation between projects is due to several casual factors which are of different importance and contribution to project correlation. The importance and the level of contribution of each factor can be estimated based on experience and judgement. Experience and judgement may easily be expressed in semantic measures rather than mathematical terms. Classical portfolio theory fails to incorporate subjective information. The semantic measures can be translated into mathematical values using the fuzzy set theory. A method by which project correlation may be estimated based on experience and judgement is proposed. The method utilizes the fuzzy set theory to estimate the coefficient of correlation and the judgement uncertainty. Then, the total risk of a portfolio can be estimated.