Studied by 41 peopleWhat is risk
Uncertainty regarding loss
What do organizations add to risk
preventing reaching goals
What does society add to risk
affecting a large portion of society
What is risk management
Scientific approach to dealing with risk
How can you classify risk
frequency- how often severity- how bad
What is another word for frequency
risk likelihood
What is another word for severity
risk impact
What is expected value
frequency x severity
How do we measure risk
relative variation of actual vs. expected variation of standard deviation
What are uncertainties regarding risk
doubting ability to predict future outcomes differs across individuals when risk is the same- subjective information does not alter risk, but can alter uncertainty
What are the categories of risk
pure vs speculative static vs dynamic fundamental vs particular core vs secondary
Pure vs Speculative risk
pure- involve only 2 potential outcomes, loss or no loss ex. leave class and car is there or it was stolen speculative- you may have a loss or no loss but also a gain ex. buying a share of google, can go up, down, or stay the same
Static vs Dynamic risk
static- unchanging through time ex. chance of earthquake dynamic- changing through time ex. identity theft
Fundamental vs Particular risk
fundamental- affects large portion of population at a given time ex. hurricane particular- affects a single person or small group ex. car accident
Core vs Secondary risk
core- inherent to the fundamental activities of organization ex. UPS & risk of traffic accidents secondary- not part of the core operations of an organization ex. speculative derivative trading by UPS
Sources of risk
personal- related to individuals life property- related to potential damage of physical property liability- related to an individual being held liable for its actions or inactions financial- related to the financial standing of an individual or organization
Exposure
person or property facing risk of loss
Peril
the immediate cause or loss
Harzard
condition affecting the frequency of the severity of loss
Moral hazard
behavioral
Morale hazard
indifference
Societal hazard
legal or cultural
What are attitudes toward risk
risk neutral, risk adverse, risk seeker
Risk neutral
indifferent, value of risky situation is expected loss
Risk adverse
prefer to avoid risk, willing to pay more than expected loss to avoid risk
Risk seeker
prefer risk, would pay more than expected return to engage in risky situation
What are the burdens of risk on society
need for larger emergency funds, loss of needed goods and services, fear and worry
What are the rules of risk management
don't risk more than you can afford to lose, don't risk a lot for a little, consider the odds
What are the risk management process steps
determination of objectives identification of risks evaluation of risks consider the alternatives implement the decision evaluate and review
Determination of objectives
Post-Loss Objectives: Survival, Continuity of Operations, Earnings Stability, Continued Growth, Social Responsibility
Pre-loss objectives: economy, reduction in anxiety, meeting externally imposed obligations, social responsibility
Identification of risks
the preferred approach to risk identification is a combination approach
interviews
analysis of documents
inspections
Evaluation of risks
loss frequency- probability distributions loss severity- maximum possible loss, probable maximum loss law of large numbers- enables us to work small premiums for larger uncertain loss
Consider the alternatives
loss control- reduced level of risky activity, increased precautions loss financing- relation and self insurance, hedging, etc internal risk reduction- diversification, investments in information
What is risk control
techniques aimed at reducing number of risks faced or amount of loss
What are the types of risk financing
planned vs unplanned funded vs unfunded
Planned vs unplanned
You can create a retention plan (I will pay for any losses out of my savings account) or you can just wing it (if a loss occurs, I'll figure it out).
Funded vs unfunded
You can create an account and put money into it to pay for future losses (funded), or you can pay it out of cash flow or other sources not specifically earmarked for losses(unfunded).
How is risk viewed differently at a societal level
scientific view of risk adds the time element
What happens when you add the time element in risk
information gets ignored ex. is it fair for a younger person dying before an older person
What is the best alternative for the time element
using the number of days lost
What does risk reduction do
there is monetary and non-monetary, puts a value on human life
What are the rules of thumb to minimize risk
recognize you need a model- mental model(semiconsciously in mind)
mathematical model (more precision)
acknowledge your models limits- incorrect(logic or assumptions are wrong, do not use this)
incomplete (characteristic shared by all models, add to this)
expect the unexpected - some factors will be overlooked (changes in environment and interaction can create factors that are no longer relevant)
understand the use and user -models are evaluated as a triplet (model, application, user)
workings of a model are transparent, consistently applied, results can be reproduces and verified by others
check the infrastructure - benefits are determined how innovation is introduced
pace is different, can cause imbalance
Risk vs. Reward
the higher the risk the higher the reward
What is decision theory
Used to determine optimal strategies where a decision-maker is faced with several alternatives and an uncertain, or risky, pattern of future events
What are the steps of the decision making process
identification of various possible outcomes (no control) identification of all courses of action (control) determination of the pay-off function (combination of acts and outcomes) choosing from among various alternatives on the basis of some criterion
Pay-off
represents the matrix of the conditional values associated with all the possible combinations of acts and events
Opportunity loss/regret
the amount of profit foregone by not adopting the optimal course of action, or that which would give the highest pay-off for each possible event.
What are the pay-off matrix requirements
must not be a sequence of events courses of action and events must be clearly determined events of actions must be distinct, mutually exclusive and collectively exhaustive
Laplace principle
do not know the probabilities, assume all outcomes are equal
Maximin/Minimax principle
for risk adverse people, figure out the worst possible outcome in each scenario and pick best WORST case
Maximax/Minimin principle
for optimistic people, figure out the best case scenario, pick out the BEST possible outcome
Maximum likelihood principle
figure out which scenario is most likely to occur and then make the choice that maximizes profit with that scenario
Expectation principle
take the probability X outcome and add them altogether
Multi-stage decision proccess
rollback technique- proceeding in a backwards manner, decide later stages then earlier stages
Expected value
= probability X outcome add altogether
What is the importance of understanding individual decision making
individuals tend to be risk adverse, they prefer the sure thing rather than an uncertainty
What is the difference between organizational and individual decision making
organizational uses expected value individuals use expected utility
What is the utility theory
utility is a function of wealth increasing in wealth increasing at a decreasing rate
What is a utility function
probability X utility of the outcome square root function
What is certainty equivalent
what the square root is, where you take the risk
What are the common mistakes in decision making
ignoring implicit costs- if doing x means not being able to do y, the value of y is an opportunity cost to x failing to ignore sunk costs- may be relevant, but are not and should be ignored measuring costs and benefits as proportions rather than absolute dollar amounts- driving to save $10 on $20 and $10 on $1010 should be answered the same because it is the same amount failure to understand average-marginal distinction- must compare the benefit and cost of an additional unit of activity
What is the invisible hand
The idea that people pursuing their own self-interest actually benefit the public at large, making decision based on own best interest ex. i do not have to get vaccinated if everyone else does
Decision makers delimma
do not experience sediments that motivate people to vote, return lost wallets, etc care only about personal material costs and benefits
Postive vs Normative questions
normative- what should be ex. should we protect x positive- what will the consequences be ex. what will happen to x
Households
many households work for someone else wages/salaries are how we get compensated
Income
not evenly distributed, rich get richer and poor get poorer spend money on taxes personal saving personal consumption expenses (service we spend most money on)
What are forms of business
sole proprietorship- what most businesses are corporations- biggest
Advantages for corporations
most effective for raising money limited liability expand easily due to attracting capital life dependent of owners and capital
What is the principle agent problem
when principals and agents interests are not aligned, owners want maximum company profit and stock price, but agents want power, high pay regardless of company performance
principals
stockholders
agents
hired by stockholders to run business
What is the governments role
-Provide Legal Structure -Maintaining Competition -Redistributing Income -Reallocating Resources -Promote Stability
Provide legal structure
Sets legal status of business enterprise Ensure rights of ownership Enforcement of contracts Establishes the rules
Maintain competition
efficient competition= high competition monopoly= controlling supply
Redistributing income
transfer payments- provide relief (welfare checks) market intervention- gov modifies prices (minimum wage taxation- gov uses income tax to take more from the rich so it narrows after-tax income differences
Reallocating resources
-Externality - occurs when some of the cost or the benefits of a good are passed on to someone other than the immediate buyer or seller. -Negative externality - Production or consumption costs inflicted on a third party without compensation -Correcting negative externalities --Legislation --Specific taxes - tax confined to a particular product -Positive externality - externality that appears as a benefit to other producers/consumers, like immunizations or education. -Correcting positive externalities --Subsidize consumers (low-interest loans for college) --Subsidize suppliers (public colleges) --Provide goods via the government (postal service)
Promote stability
when total spending matches economy's production capacity the prices are stable stability is achieved when addressing unemployment and inflation
How do we balance competing goals
if the free market worked well, we would not have to worry about the government protecting ourselves from ourselves government could focus on externalities in economic perspective people get "different pieces of the pie"
How do we maximize with measurment
Bentham- urged politicians to design policies that maximized peoples happiness treat to libertarians- replaces the individualized version of well being "happy slave"- poor your whole life and happy, does that make it okay
Is there a simple answer for happiness
no, in policy decisions there needs to be a balance between number of competing objectives when making these decisions education, freedom, well-being is measured would we get a better idea of what we really want the government to do
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