Using financial derivatives to hedge against market risks in IT outsourcing projects – a quantitative decision model

Abstract

Besides the project-inherent risk of an IT outsourcing project, related to the management of the project, other types of risk driven by the marketshave not yet been addressed until now. Although financial derivatives are well known as a powerful tool for hedging market risk, there are no approaches to utilize this tool for risk management in IT outsourcing projects. We show a way to address two types of market risk threatening outsourcing success: insolvency of the project counterpart and a slump in prices of the counterpart's stocks. This paper therefore provides a quantitative decision model to determine how much money should be spent on hedging these risks using financial derivatives. We discover that the lower the probability of damage the higher the degree of cheap hedging that should be applied. In contrast, other means of hedging should be considered when facing a rather high probability of damage, because financial hedging gets too expensive.

Financial exposure and technology innovation investment

“…The RO approach is used to evaluate projects with sunken costs, uncertainties, and managerial flexibility. In our literature review, the most relevant works and recent research includes that of Benaroch (2002), Bardhan et al (2004), Wu and Ong (2008), Ghosh and Troutt (2012), Buhl et al (2013), Ghosh and Li (2013) and Arasteh (2016).…”