... Notes are saved with you account but can also be exported as plain text, MS Word, PDF, Google Doc, or Evernote. party insulated from risk may behave differently from the way it would behave if it were fully harmful or negative effect. Unfortunately the sample becomes self-selecting and so may be biased. This is the expected value ofprofits if a geologist is employed and exceeds the EV of profits if sheis not employed. The investor would look at the worstpossible outcome at each supply level, then selects the highest one ofthese. diversification minimizes the risk from any one investment. It can include all random events that mightaffect the success or failure of a proposed project - for example,changes in material prices, labour rates, market size, selling price,investment costs or inflation. If however we supply 50 salads but only 40 are sold, our profits will amount to 40 x $2 - (10 unsold salads x $8 unit cost) = 0. Basic Concepts 1. Assess the use of simulation for a chain of betting shops. company. Internal company data is perhaps the most neglected source of marketing information. Uncertainty is a lack of complete certainty. For example, if the target population is 55% women and 45% men, then a sample of 200 people could be structured so 110 women and 90 men are asked, rather than simply asking 200 people and leaving it up to chance whether or not the gender mix is typical. Test your understanding 2 - Applying maximax. A manager employingthe minimax regret criterion would want to minimise that maximum regret,and therefore supply 40 salads only. Ithas a number of potential films that it is considering producing, one ofwhich is the subject of a management meeting next week. Their cost and logistical complexity is frequently cited as a barrier, especially for smaller companies. of a risk-free investment. the risks surrounding a business or investment. Copyright 2020. business risk, while still allowing the business to profit from an investment activity. If there is no oil, the probability that she willsay prospects are poor is 85%. describe generally available research techniques to reduce uncertainty, e.g. Step 1: Draw the tree from left to right, showing appropriate decisions and events / outcomes. Differences:  In risk, you can predict the possibility of a future outcome while in uncertainty you cannot exposed to the risk. FREE Sign up. A decision tree is a diagrammatic representation of amulti-decision problem, where all possible courses of action arerepresented, and every possible outcome of each course of action isshown. A university is trying to decide whether or not to advertise a new post-graduate degree programme. Uncertainty refers to the situation where probabilities cannot be assigned to expected outcomes. (a)You have the mineral rights to a piece ofland that you believe may have oil underground. Label the tree and relevant cash inflows/outflows and probabilities associated with outcomes. Following up from the pay-off table example, Geoffrey Ramsbottom's table looks as follows: The manager who employs the maximax criterion is assuming thatwhatever action is taken, the best will happen; he/she is a risk-taker.How many salads will he decide to supply? She can tellyou whether the prospects are good or poor, but she is not a perfectpredictor. Simulation allows us to change more than one variable at a time. Please sign in or register to post comments. Word association testing – on being given a word by the interviewer, the first word that comes into the mind of the person being tested is noted. The following estimatesare made: Since the expected value shows the long run average outcome of adecision which is repeated time and time again, it is a useful decisionrule for a risk neutral decision maker. It is often used in capital investment appraisal. These would then be matched to the random numbersassigned to each probability and values assigned to 'Sales Revenues' and'Costs' based on this. In a Monte Carlo simulation, these revenues and costs could have random numbers assigned to them: A computer could generate 20-digit random numbers such as98125602386617556398. loss. Risks can be managed while uncertainty is uncontrollable. Project B has a higher average profit but is also more risky (more variability of possible profits). Group interviewing – where between six and ten people are asked to consider the relevant subject (object) under trained supervision. We should therefore decide to supply 70 salads a day. Risks and Uncertainties. 978 Simona-Valeria Toma et al. Project A has a lower average profit but is also less risky (less variability of possible profits). It provides an organisation with a picture of past and future trends in the environment and with an indication of the company's position in the economy as a whole. Chinese, were completely unaware of probabilities and the quantification of risk. Content: Risk Vs Uncertainty It is concerned with such factors as gross national product (GNP), investment, expenditure, population, employment, productivity and trade. In uncertainty, the outcome of any event is entirely unknown, and it cannot be measured or guesses; you don’t have background information on the event. A complex problem is brokendown into smaller, easier to handle sections. The random numbers generated give 5 possibleoutcomes in our example: A business is choosing between two projects, project A and projectB. If we decide to supply 60 salads, the minimum pay-off is ($80). The Monte Carlo simulation method uses random numbers andprobability statistics. If wedecide to supply 50 salads, the maximum regret is $80. There is no correct answer. focus groups, market research; suggest for a given situation, suitable research techniques for reducing uncertainty; explain, using a simple example, the use of simulation; explain, calculate and demonstrate the use of expected values and sensitivity analysis in simple decision-making situations; for given data, apply the techniques of maximax, maximin and minimax regret to decision making problems including the production of profit tables; calculate the value of perfect information; calculate the value of imperfect information. Thus it is clear then that though both ‘risk and uncertainty’ talk about future losses or hazards, while risk can be quantified and measured; there is no known way of ascertaining uncertainty. The maintypes of measurement are: Random sampling– where each person in the targetpopulation has an equal chance of being selected. Chapter 4 – Pricing Theory and Practices. 2.1 Concept of risk and uncertainty a) Risk In the simple manner risk is the probability of deciding the method or the opportunities for the better output. Risks are events or conditions that may occur, and whose occurrence, if it does take place, has a whether to advertise the programme, or not advertise.). the other party. Author: Saral Notes. If there is no oil, the probability that she willsay prospects are poor is 85%. Uncertainty Uncertainty is a situation regarding a variable in which neither its probability distribution nor its mode of occurrence is known. There is only a 10%chance that you will strike oil if you drill, but the profit is$200,000. For example, the same oil company may dig for oil in a previouslyunexplored area. Market research findings, for example, are likely to bereasonably accurate - but they can still be wrong. predict the possibility of a future outcome. Synonyms for uncertainty include: unpredictable, unreliability, riskiness, doubt, indecision, unsureness, misgiving, apprehension, tentativeness, and doubtfulness. Risk management is important in a business. In the context of risk, we often can examine t… Disclosure can be a tool for companies to communicate how they are navigating through such uncertainty. Choose the best option at each decision point. Using maximax, an optimist would consider the best possible outcomefor each product and pick the product with the greatest potential. In uncertainty, you completely lack the background Risk and Uncertainty The concept of (fundamental) uncertainty was introduced in economics by Keynes (1921, 1936 and 1937) and Knight (1921). Some of the more common techniques in motivational research are: Measurement research – the objective here is to build on the motivation research by trying to quantify the issues involved. Sensitivity analysis takes each uncertain factor in turn, andcalculates the change that would be necessary in that factor before theoriginal decision is reversed. It assumes that changes to variables can be made independently, e.g. If a firm can obtain a 100% accurateprediction they will always be able to undertake the most beneficialcourse of action for that prediction. Essentially,this is the technique for a ‘sore loser' who does not wish to make thewrong decision. How many salads should we supply, using the Maximin rule? Copyright © 2020 StudeerSnel B.V., Keizersgracht 424, 1016 GC Amsterdam, KVK: 56829787, BTW: NL852321363B01, Coursebook Economics of Information 2019 20. A powerful computer is then used to repeat the decision many timesand give management a view of the likely range and level of outcomes.Depending on the management's attitude to risk, a more informed decisioncan be taken. by an individual or an organisation. Knight argues that the second individual is exposed to risk but that the first suffers from ignorance. Knowing the difference between risk and uncertainty will help us make better decisions. Non-Insurable Risk 4. a person takes more risks because someone else bears the cost of those risks. Here C would be chosen with a maximum possible gain of 100. Label the tree and relevant cash inflows/outflows and probabilities associated with outcomes : (a)   Calculate an Expected Value at each outcome point. For example, it may be that the estimated selling price can fall by 5% before the original decision to accept a project is reversed. Now let's look at the different values of profit or losses depending on how many salads are supplied and sold. It is the process ofunderstanding and managing the risks that an organisation is inevitablysubject to. Sample surveys are used to find out how many people buy the product, what quantity each type of buyer purchases, and where and when the product is bought. The certainty equivalent method converts expected risky profit streams to their certain sum equivalents to eliminate value differences that result from different risk levels. Decision-making under Certainty: . Almost all economic transactions involve Upon completion of this chapter you will be able to: Risk is the variability of possible returns. Imperfect information The forecast is usually correct, but can be incorrect. Uncertainty is a lack of complete certainty. Answer - University advertising decision tree. Risk 3. If there is oil, the probability that she will say there aregood prospects is 95%. For example, if the demand is 40 salads, we will make a maximumprofit of $80 if they all sell. Takes uncertainty into account by considering the probability of each possible outcome and using this information to calculate an expected value. Step 3: Recommend a course of action to management. – ex. 978 Simona-Valeria Toma et al. This created an imbalance of power and in transactions which can Observation– e.g. Panelling– where the sample is kept for subsequent investigations, so trends are easier to spot. – ex. This normally happens when the seller of a good or service has greater knowledge The company knows that it is possible for them toeither find or not find oil but it does not know the probabilities ofeach of these outcomes. Prof. Dr. Svetlozar Rachev (University of Karlsruhe) Lecture 6: Risk and uncertainty 2008 4 / 100 of its actions. For example, based on past experience of digging for oil in aparticular area, an oil company may estimate that they have a 60% chanceof finding oil and a 40% chance of not finding oil. We will calculate the Expected Value of profits if we employ the geologist. If the business is willing to take on risk, they may prefer project B since it has the higher average return. Following up from the pay-off table example, Geoffrey Ramsbottom's table looks as follows : How many salads should we decide to supply if the minimax regret rule is applied? – ex. Itsstaff has asked you to help them decide how many salads it should supplyfor each day of the forthcoming year. It will not tell the business which is thebetter project. The entire disclosure for any concentrations existing at the date of the financial statements that make an entity vulnerable to a reasonably possible, near-term, severe impact. Conversely, many companies, especially blue-chips and public services, can often be seen to produce reams of data for no apparent reason, or because 'we always have done'. The following are a few differences between risk and uncertainty: 1. This article introduces the concepts of risk and uncertainty together with the use of probabilities in calculating both expected values and measures of dispersion. Asymmetric Information- Is present one party to a transaction has more or better information that Lecture notes in Risk & Uncertainty. Risk: there are a number of possible outcomes and the probability of each outcome is known. The minimax regret strategy is the one that minimises the maximumregret. Information will be presented to management in a form which facilitates subjective judgement to decide the likelihood of the various possible outcomes considered. Factors to consider when using desk research. Podcast Episode 292—Decision Making: Uncertainty Versus Risk. Step 1: Draw the tree from left to right. Risk, Uncertainty, and the Precautionary Principle 2. Nevertheless, there is evidence that people can learn from warnings and risk information, such The objective of risk assessment is to conduct an assessment to bode negative effects so that adverse outcome can be minimized. There is a 60% chance that economic conditions will be poor. The more variable these outcomes are the greater the risk. The maximum possible change is often expressed as a percentage.This formula only works for total cash flows. Therefore, the contributionper salad is $2. Market intelligence is information about a company's present or possible future markets. Distinction between risk and uncertainty. insured. Expected costs (advertising, promotion and marketing) have alsobeen estimated as follows: there is a 20% chance they will reachapproximately $248,000; 60% chance they may get to $260,000 and 20 %chance of totalling $272,000. odds of being killed on a single airline flight are 1/29 million Estimated probability (uncertainty) – Most common, demands judgment Using maximax, which product would be chosen? odds of being killed on a single airline flight are 1/29 million Estimated probability (uncertainty) – Most common, demands judgment It identifies areas which are crucial to the success of the project. For example, if you are filling in an insurance proposal The MP Organisation is an independent film production company. through the use of cameras withinsupermarkets to examine how long customers spend on reading thenutritional information on food packaging. Examination. Well, this article might help you in understanding the difference between risk and uncertainty, take a read. When the level of risk and the attitudes toward risk taking are known, the effects of uncertainty can be directly reflected in the basic valuation model of the firm. It costs $10,000 to drill. Geoffrey Ramsbottom runs a kitchen that provides food for variouscanteens throughout a large organisation. Illustration 8 - The 'Minimax Regret' rule. However, it is quicker and cheaper than field research. material prices will change independently of other variables. If we employ the geologist, the probabilities of her possibleassessments can be tabulated as follows (assume 1,000 drills in total): A decision tree can be drawn to calculate the expected value of profits if a geologist is employed: EV(A) = (41.30% x $200,000) - $10,000 drilling costs = $72,600.The decision at 'C' should be to drill, as this generates higherbenefits than not drilling. A new ordering system is being considered, whereby customers mustorder their salad online the day before. It is not a technique for making a decision, only for obtaining more information about the possible outcomes. With this new system MrRamsbottom will know for certain the daily demand 24 hours in advance.He can adjust production levels on a daily basis. assign probabilities to each of these possible outcomes, risk is said to exist. Lecture notes in Risk & Uncertainty. Uncertainty refers to the situation where probabilities cannot be assigned to expected outcomes. In risk you can predict the possibility of a future outcome, while in uncertainty you cannot. Draw a decision tree to represent your problem. The information is reduced to a single number resulting in easier decisions. If conditions are poor it is expected that the programme will attract 40 students without advertising. For example, if we supply 40 salads and all are sold, our profits amount to 40 x $2 = 80. Moral hazard- Occurs when someone increases their exposure to risk when insured, especially when The Value of Perfect and Imperfect Information. decision. All simulation will do is give thebusiness the above results. EV(B) = (0.65% x $200,000) - $10,000 drilling costs = -$8,700. To fight adverse selection, insurance companies reduce exposure to large Against this backdrop of uncertainty, detailed and useful disclosure may be a challenge for boards. Based upon past demands, it is expected that, during the 250-dayworking year, the canteens will require the following daily quantities: The kitchen must prepare the salad in batches of 10 meals. tomorrow then there is uncertainty but no risk as there is no monetary loss. We can now construct a pay-off table as follows: When probabilities are not available, there are still tools available for incorporating uncertainty into decision making. Subject: Managerial Economics. Economic intelligence can be defined as information relating to the economic environment within which a company operates. Insurance is a means of protection from financial loss. determine the amount, called the premium, to be charged for a certain amount of insurance Which project should the business invest in? Share Related Material. We should drill, because the expected value from drilling is $10K, versus nothing for not drilling. Under conditions of certainty, accurate, measurable, and reliable information on which to base decisions is available. Probability Analysis 5. It’s the prospect that a A circle is used to represent a chance point. In summary it suggest when faced with missing or imperfect information about an event, probability, or outcome, we are uncertain.Continue Reading Management Notes – On – Risk And Uncertainty – For W.B.C.S. Why pandemics are highly uncertain and should be treated as such. It uses simulation to generate a distribution of profits for eachproject. If we decide to supply 40 salads, the maximum regret is $60. A square is used to represent a decision point (i.e. When a range of potential outcomes is associated with a decision and the decision maker is able to than the buyer, although the reverse is possible. Download all ACCA course notes, track your progress, option to buy premium content and subscribe to eNewsletters and recaps. Rarely is the information collected in a form in which it can readily be used by marketing management. If we decide to supply 70 salads, the minimum pay-off is ($160). Difference between Risk and Uncertainty. Surveying by post– the mail shot method. The group is interviewed through facilitator-led discussionsin an informal environment in order to gather their opinions andreactions to a particular subject. If the insurance company knew who smokes and Information is collected from primary sources by direct contact with a targeted group. The model identifies key variables in a decision : costs andrevenues, say. In addition to the research techniques discussed, the following methods can be used to address risk or uncertainty. Uncertainty is different to risk. In ISO 9000:2015, within the definition of risk a note expands on the term uncertainty. There is a 40% chance that economic conditions will be good. Adverse Selection- Refers generally to a situation where sellers have information that byers do not A person or entity who buys insurance is known as an Although it is more expensive and time consuming than desk research the results should be more accurate, relevant and up to date. (b) Choose the best option at each decision point. Depth interviewing – undertaken at length by a trained person who is able to appreciate conscious and unconscious associations and motivations and their significance. 3. refers to the chance that you will encounter an outcome that differs from the expected outcome. An investment decision is Typically, it involves posing 'what-if'questions. This is why it is necessary to recognize uncertainty and risk along with the notes that distinguish them, so that the attitude towards them can be further nuanced "Prunea, 2003. (b) We will calculate the Expected Value of profits if we employ the geologist. Uncertainty: there are a number of possible outcomes but the probability of each outcome is not known. (b)   Choose the best option at each decision point and recommend a course of action to management. tomorrow then there is uncertainty but no risk as there is no monetary loss. The formula for the expected value is EV = Σpx. If 40 salads will be required on 25 days of a 250-day year, the probability that demand = 40 salads is : Likewise, P(Demand of 50) = 0 .20; P(Demand of 60 = 0.4) and P(Demand of 70 = 0.30). Risk is thus closer to probability where you know what the chances of an outcome are. This meanswe need to find the biggest pay-off for each demand row, then subtractall other numbers in this row from the largest number. Test your understanding 3 - Applying maximin. Lecture Notes: General Insurance Lecture 8: Risk and uncertainty in pricing and reinsurance By Omari C.O 1 Risk and uncertainty in pricing and reinsurance 1.1 Introduction Insurance contracts transfer elements of risk and uncertainty from customers to insurers. to get life insurance. coverage. Perfect information is only rarely accessible. Such samples are morelikely to be representative, making predictions more reliable. Subject: Managerial Economics. The financial outcomes and probabilities are shown separately, andthe decision tree is ‘rolled back' by calculating expected values andmakingdecisions. For example, press articles, published accounts, census information. One could say the penguin's uncertainty about the outcome of his next step is the risk, but here you need both the event of him taking a step, and uncertainty in the event outcome to make up the risk. A key Created at 5/24/2012 4:39 PM  by System Account, (GMT) Greenwich Mean Time : Dublin, Edinburgh, Lisbon, London, Last modified at 5/25/2012 12:54 PM  by System Account. unknown, and it cannot be measured or guesses; you don’t have background information on the If the minimax regret rule is applied to decide how many saladsshould be made each day, we need to calculate the 'regrets'. In summary, risk refers to the potential variability of outcomes from a decision. Individuals may feel under pressure to agree with other members or to give a 'right' answer. Many biases in risk assessment and regulation, such as the conservatism bias in risk assessment and the stringent regulation of synthetic chemicals, reflect a form of ambiguity aver-sion. Risk and Uncertainty 1. The insurance transaction involves the insured assuming a guaranteed and known relatively Each of the variables is analysed in turn to see how much the original estimate can change before the original decision is reversed. For example, a supermarket may use a focus group before a productlaunch decision is made in order to gather opinions on a new range ofpizzas. This is because a risk neutral investor neither seeks risk or avoids it; he is happy to accept an average outcome. The question is as follows : how much would it be worth paying for such imperfect information, given that we are aware of how right or wrong it is likely to be? It obtains existing data by studying published and other available sources of information. Diversification: Is a risk management technique that mixes a wide variety of investments within a If the external purchase price rose bymore than 17% the original decision would be reversed. F.H., 1921, Risk, Uncertainty and Profit, New York Hart, Schaffner and Marx. Such information will be both commercial and technical, for example, the level of sales of competitors' products recorded by the Business Monitor or Census of Production; the product range offered by existing or potential competitors; the number of outlets forming the distribution network for a company's products; the structure of that network by size, location and relation to the end user; and the best overseas markets for a company. measures the uncertainty that an investor is willing to take to realise a gain from an investment. Some, such as Southwest Airlines, have made extensive use of financial instruments to hedge fuel risks, whereas others leave positions open. Triad testing – where people are asked which out of a given three items they prefer. In fact, informationsources such as market research or industry experts are usually subjectto error. Risk & Uncertainty. This forecast may turn out to becorrect or incorrect. The difference, or 'regret' between thatnil profit and the maximum of $80 achievable for that row is $80. sometimes cause the transactions to go awry. It cannot be used for individual units, selling prices, variable cost per unit, etc. This sort of information can also be collected in retail environments at the point of sale, for example, through the use of loyalty cards. COVID-19 - Going concern, risk and viability 3 Quick Read The COVID-19 crisis and responses to it are creating unprecedented global uncertainty. small loss in the form of a payment to the insurer in exchange for the insurer’s promise to rolling a dice, roulette wheel Statistical probability: Observed frequencies used to predict outcomes. Profits are therefore maximised at 50 salads and amount to $90. Possible outcomes are easy to identify (e.g. When the level of risk and the attitudes toward risk taking are known, the effects of uncertainty can be directly reflected in the basic valuation model of the firm. A perfect hedge In summary, risk refers to the potential variability of outcomes from a Clearly, risk permeates most aspects of corporate decision-making (and life in general), and few can … An entity which provides insurance is ⇒ Risk is qualified as an asymmetric phenomenon in the sense that it is related to loss only. The maximin rule involves selecting the alternative that maximisesthe minimum pay-off achievable. The essence of that, though, is along the way, in addition to this uncertainty, you have this layer of risk with everything you're doing. For indifference, the contribution from outsourcing needs to fallto $5 per unit. This approach would be suitable for an optimist, or 'risk-seeking'investor, who seeks to achieve the best results if the best happens. An expected value is a weighted average of all possible outcomes.It calculates the average return that will be made if a decision isrepeated again and again. If we had decided to supply 50 salads,we would achieve a nil profit. The more variable these outcomes are the greater the risk. Each time you hire a new person, you're taking a risk. Conversely, uncertainty refers to a condition where you are not sure about the future outcomes. Here, the highest maximum possible pay-off is $140. known as an insurer or an insurance company. Distinction between risk and uncertainty. Hi John, the concept has been well explained in the lecture, the assumption is the spread is a normal distribution and hence the graph is symmetrical and hence there is a 50% chance of the return being higher or lower than the average return. said to be risk free if the outcome is known with certainty. Risk and Uncertainty. This Product includes content from the International Auditing and Assurance Standards Board (IAASB) and the International Ethics Standards Board for. She can tellyou whether the prospects are good or poor, but she is not a perfectpredictor. It is only of any real value, however, if theunderlying probability distribution can be estimated with some degreeof confidence. For example, what is the chance of the selling price falling by more than 5%? Wir haben es uns zum Lebensziel gemacht, Ware jeder Art ausführlichst zu testen, sodass Käufer schnell den Risk and uncertainty in economics notes bestellen können, den Sie zu Hause für geeignet halten. Using maximin, a pessimist would consider the poorest possible outcome for each product and would ensure that the maximum pay-off is achieved if the worst result were to happen. risk and uncertainty by syed muhammad ijaz, fca dated august 03, 2007 ... no notes for slide. Working from top to bottom, we can calculate the EVs as follows: EV (Outcome Point A) = (35% x $100,000) + (65% x $150,000) = $132,500, EV (Outcome Point B) = (0% x $0) + (25% x $25,000) = $6,250, EV (Outcome Point C) = (60% x $115,000) + (40% x $15,000) = $75,000, EV (Outcome Point D) = (60% x $132,500) + (40% x $6,250) = $82,000. ‘Regret' in this context is defined as the opportunity loss through havingmade the wrong decision. This helps to model what is essentially a one-off decision usingmany possible repetitions. A great deal of information is freely available in this area from sources such as government ministries, the nationalised industries, universities and organisations such as the OECD. Contents: 1. Decision-making under Certainty A condition of certainty exists when the decision-maker knows with reasonable certainty what the alternatives are, what conditions are associated with each alternative, and the outcome of each alternative. In uncertainty, the outcome of any event is entirely where a choice between different courses of action must be taken. Chapter 4 – Pricing Theory and Practices. They can test the market e.g. The highest minimum payoff arises from supplying 40 salads. However,  Risks can be measured and quantified while uncertainty cannot. A particular salad is sold tothe canteen for $10 and costs $8 to prepare. Therefore, our analysis must extend to deal with imperfect information. Thus the external purchase price only needs to increaseby $1 per unit (or $1/ $6 = 17%). For both options, a circle is used to represent a chance point - a poor economic environment, or a good economic environment. Using the information from the previous TYU apply the maximin rule to decide which product should be made. At the first (and only) decision point in our tree, we shouldchoose the option to advertise as EV ('D') is $82,000 and EV ('C) is$75,000.

risk and uncertainty notes

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