Building uncertainty into cost-effectiveness rankings: portfolio risk-return tradeoffs and implications for decision rules

B J O'Brien, M J Sculpher

Research output: Contribution to journalArticlepeer-review


BACKGROUND. Current principles of cost-effectiveness analysis emphasize the rank ordering of programs by expected economic return (eg, quality-adjusted life-years gained per dollar expended). This criterion ignores the variance associated with the cost-effectiveness of a program,yet variance is a common measure of risk when financial investment options are appraised. Variation in health care program return is likely to be a criterion of program selection for health care managers with fixed budgets and outcome performance targets.

METHODS. Characterizing health care resource allocation as a risky investment problem, we show how concepts of portfolio analysis from financial economics can be adopted as a conceptual framework for presenting cost-effectiveness data from multiple programs as mean-variance data.

RESULTS. TWO specific propositions emerge: (1) the current convention of ranking programs by expected return is a special case of the portfolio selection problem in which the decision maker is assumed to be indifferent to risk, and (2) for risk-averse decision makers, the degree of joint risk or covariation in cost-effectiveness between programs will create incentives to diversify an investment portfolio.

CONCLUSIONS. The conventional normative assumption of risk neutrality for social-level public investment decisions does not apply to a large number of health care resource allocation decisions in which health care managers seek to maximize returns subject to budget constraints and performance targets. Portfolio theory offers a useful framework for studying mean-variance tradeoffs in cost-effectiveness and offers some positive predictions (and explanations) of actual decision making in the health care sector.

Original languageEnglish
Pages (from-to)460-468
Number of pages9
JournalMedical Care
Issue number5
Publication statusPublished - May 2000


  • portfolio theory
  • risk-return
  • diversification
  • resource allocation
  • cost-effectiveness

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