Letter from the Editor

The Engineering Economist seeks submissions in a number of areas, including but not limited to capital investment analysis, financial risk management, cost estimation and accounting, cost of capital, design economics, economic decision analysis, engineering economy education, research and development, and the analysis of public policy when it is relevant to the economic investment decisions made by engineers and technology managers. This issue contains three articles that primarily contribute one of these areas, financial risk management. I would like to thank all reviewers who contributed to the peer-review process as well as associate editors Dave Enke and Sarah Ryan (former editor-in-chief) for their contributions to this issue. The issue begins with an article entitled “Average Internal Rate of Return for Risky Projects” by Gordon Hazen and one of our own area editors Carlo Magni Alberto. Their work extends prior work on average internal rate of return (AIRR) to risky capital asset projects, a domain where the IRR appears intractable. They show that an analyst can uniquely break down a risky NPV into a risk-sensitive project scale and a risk-sensitive extended AIRR, representing risky project efficiency, so that consistency with NPV for accept/reject decisions is maintained in the certainty-equivalent sense, in direct analogy to the deterministic case. This novel breakdown gives managerial insight by helping determine a risky project’s locus of uncertainty, be it the project scale, or economic efficiency, or both. In “Term Structures and Scenario-Based Social Discount Rates under Smooth Ambiguity” by Kyoung-Kuk Kim, Dowon Kim, and Jiwoong Lee, social discount rates based on the Ramsey rule are explored. The rule has been augmented in various ways in order to reflect the decision maker’s attitude toward risk and uncertainty. The authors develop a general social discount rate formula via the utility gradient method, which obtains the three-way explicit separation of risk aversion, intertemporal substitution, and ambiguity aversion. The generality of this approach enables directly applying well known growth scenarios under climate change to derive scenario-based social discount rates, which can be used as a guide in practice to assess climate change policies or related projects. In the last article, area editor Roy Kwon, David Islip, and Jason Wei coauthor “Managing Construction Risk with Weather Derivatives.” The authors state that among construction industry participants, weather has been perceived to be one of the most critical factors impacting project cash-flows. This article presents a framework that leverages stylized facts from the construction industry to motivate the use of weather derivatives in managing the non-trivial weather impacts. They show that weather derivative portfolios used for hedging purposes by the contractor can address the contractor’s aversion for losses as well as the complicated relationship between weather and construction. The Engineering Economist publishes articles, case studies, surveys, and book and software reviews that represent original research, current practice, and teaching involving problems of capital investment. For questions or inquiries, please contact me at hln@uark.edu.