Risk

1
Risk

• Decision Making Under Uncertainty Class 13

2
Risk

• Is the potential that a chosen action or activity
  (including the choice of inaction) will lead to a
  loss (an undesirable outcome).
• The notion implies that a choice having an
  influence on the outcome exists (or existed).
• Potential losses themselves may also be called
  "risks".
• Almost any human endeavor carries some risk, but
  some are much more risky than others.

3
Risk Normative Theory

• Reduction of risk usually has a cost
• The marginal utility of money spent on risk
  reduction is declining.
• The cost of reducing each percent of risk goes
  up, the benefit ( excepted utility terms) of a 1
  reduction is the same.
• 1 - 0 or 20 - 19.
• If the benefit is the same for each percent
  change in risk but the marginal utility is
  declining it follows that an Optimal amount of
  risk reduction.
• Cost of reducing the next 1 is greater than the
  reduction in the expected disutility.
• There is an optimal amount of risk
• Risk reduction can be measured as a decrease in
  the probability of some bad event happening to a
  single person in a year.
• Risk drives us to make decisions regarding the
  allocation of resouces.

4
Public Control of Risk

• Public mechanisms for risk control
• Direct expenditure of public funds
• Public safety
• Regulation
• Places cost of risk reduction on those who engage
  in risky activity.
• Provision of information
• Provide information on activities that have
  higher levels of risk.
• Tort System (Lawsuits)
• Negligence
• Who is responsible
• Compensation

5
Risk Regulations

• Why do some agencies or governments spend more
  money in one area but not another?
• Psychometric Approach
• Focus on the characteristics of the risk and
  their acceptability
• Unknown, new, involuntary and delayed
• Food coloring, food preservation, pesticides,
  spray cans (high reg)
• Hunting, motorcycles, fire fighting, mountain
  climbing
• Severity of consequences, dread and catastrophic
• Aviation, nuclear power (high)
• Lawn mowers, appliances

6
Risk Regulations cont

• Voluntary vs Involuntary
• Spend more money on involuntary risks
• Cars vs motorcycles vs airplanes
• Obesity vs smoking vs drinking
• Known vs Unknown
• GMO grains, medicines
• How much uncertainty is acceptable?
• Catastrophic vs Individual
• Decisions that may result in catastrophic lose is
  perceived to require more regulation that one
  which has equivalent individual lose.

7
Risk Proportions vs Differences

• Changes in risk
• Concern more about the proportion of risk reduced
  than the difference in the number of people
  involved.
• Utilitarianism implies the number is more
  important
• Each person is independent
• Expected utility theory says number is best
• Number translates into probability
• Risk vs Relative Risk
• Which is most relevant for decision making?
• Studies show relative risk was more influential
  in peoples willingness to pay for safety

8
Zero Risk

• Is this plausible?
• Does it have the utility that we perceive?
• How much are you willing to pay in terms of
  resources to achieve.

9
Risk Natural vs Artificial

• Is there a bias towards risk caused by artificial
  means?
• If so then why?
• Are we willing to pay more to reduce risks caused
  by humans?
• Omission versus Commission

10
Risk Insurance and Protective Behavior

• Insurance is justified in terms of declining
  marginal utility of wealth.
• Or increasing marginal disutility of loses
• Do not buy insurance for small losses
• Utility of money is linear for small losses
• More willing to buy insurance from a human source
  than a natural source.
• Rebate versus lower premiums
• Willingness to pay for insurance depends on the
  vividness of the imaged event.

11
Investors and Entrepreneurs

• Risk Tolerance
• Investment Manager Risk
• aspect of risk

12
Individual and Sex differences

• Is there a difference between the way men and
  women address risk?
• Is there a difference between how different
  ethnics or cultures perceive risk?