Explain the difference between Risk and Uncertainty.
Risk is when there is more than one possible future outcome and the probability of each outcome CAN estimated.
Uncertainty is when there is more than one possible future outcome and the probability of each outcome CANNOT be estimated.
What is sensitivity analysis used for?
Sensitivity Analysis is used to measure the margin of safety of any variables subject to uncertainty.
What are the 4 Attitudes to risk?
- Risk Seeker
- Risk Averse
- Regret Averse
- Risk Neutral
What characterises someone with a “Risk Seeker” attitude to risk?
Someone who will seek high returns and is prepared to accept high risk.
What characterises someone with a “Risk Averse” attitude to risk?
They will look to limit risk and make low risk choices.
These low risk choices usually mean low returns.
What characterises someone with a “Regret Averse” attitude to risk?
They will seek to minimise the adverse impact of “getting things wrong”.
What characterises someone with a “Risk Neutral” attitude to risk?
Will ignore risk and focus on a statistical value.
This is called Expected Monetary Value
What risk model would someone who is “Risk Seeking” look to implement?
MAXIMAX
What risk model would someone who is “Risk Averse” look to implement?
MAXIMIN
What risk model would someone who is “Regret Averse” look to implement?
MINIMAX REGRET
What risk model would someone who is “Risk Neutral” look to implement?
Expected Monetary Value
When a number of potential investments are on offer, what will the MAXIMAX model suggest?
It will suggest choosing the option with the best possible “best outcome”
When a number of potential investments are on offer, what will the MAXIMIN model suggest?
It will suggest choosing the option with the best possible “worst outcome”
When a number of potential investments are on offer, what will the MINIMAX Regret model suggest?
It will suggest the option with the lowest posssible highest opportunity cost for all of the possible outcomes.
Expected monetary value is more effective when based on what type of probability:
A. Subjective probability
B. Objective probability
B. Objective probability
When there is a data set that validifies the probability from past event
A Panel of experts come together and decide that the probability of a Liverpool beating everton is 99%. is this:
A. Obejective probability
B. Subjective probability
B. Subjective probability
What are some limitations of Expected Monetary Value?
There are 3.
- It assumes that the probabilities used to calcuate are accurate.
- Only reliable when Objective information is used.
- Expected value is an average of all possible outcomes, not what we actually expect to happen.
What are the 4 stages of the decision tree method?
- Draw the tree
- Assign the probabilities
- Calculate the monetary value of each possible outcome.
- The backwards pass
What are the 2 types of nodes in a decision tree?
- Event Node
- Decision Node
How does the backwards pass stage of a decision tree work?
Carry the monetary values back to each node. If it is an event node calculate the expected value (of all possible outcomes) using the probabilities. If it is a decision node carry back the best option and put a barrier (/) on each of the other oprions to show they will be rejected.
A square node in a decision tree represents a?
A decision node.
A circle node in a decision tree represents a?
Event node.
What are some 4 limitations of a decision tree?
- The “answer” is an expected value and is a weighted average of all possible oucomes resuting from a decision and does not represent the actual outcome.
- The use of expected values implies a risk neutral attitude.
- The analysis is only as accurate as the data estimates used in the making of the decision tree.
- It only considers the financial side to a decision, when i reality many other factors may need to be considered. Especially in a public organisation.
What does Sensitivity analysis measure?
It measures the responsivness of the final outcome to a change in a single variable.
