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Hubbard +## Mentioned Topics and Abbreviations + +* Analytic Hierarchy Process (AHP) +* Multi-Attribute Utility Theory (MAUT) +* Actuarial Science +* Options Theory (OT) +* Modern Portfolio Theory (MPT) +* Probabalistic Risk Analysis (PRA) +* Value at Risk (VaR) +* Loss-Exceedance Curve (LEC) +* Risk Tolerance +* Certain Monetary Equivalent (CME) + * also called Certainty Equivalent + ## Key Takeaways ### Definition of Risk @@ -39,16 +53,44 @@ that they are "better than nothing". Expected Value (Probability × Magnitude) alone can not predict or inform risky decisions, -except for risk-neutral parties. -People and organizations are risk-averse -%% TODO: ... %% +except for risk-neutral parties, +but people and organizations are risk-averse. + +Game 1: Which would you pick? +* Option 1: a 100% chance to receive $10,000 +* Option 2: a 10% chance to receive $100,000 + +Most people, being risk-averse, will pick option 1. +Suppose the prize of option 1 were lowered +until you would pick option 2. + +That value is your **Certain Monetary Equivalent (CME)** +for a 10% chance of $100,000. For risk-neutral parties, expected value = CME +Another factor at play here +is that utility is not proportional to monetary value. + +Consider these additional choices: + +Game 2: +* Option 1: a 100% chance to receive $1,000 +* Option 2: a 10% chance to receive $10,000 + +Game 3: +* Option 1: a 100% chance to receive $100,000 +* Option 2: a 10% chance to receive $1,000,000 + +Assuming that the value of one dollar were linear, +all three games should have the same solution, +but in reality one's answers will differ. + ### Expert Opinion Must Be ~~Adjusted~~ Expert opinion is valuable despite its flaws. -%% TODO: ... %% + + The book details the statistically observable tendency for people to underestimate risk and to be overconfident in their beliefs. @@ -127,7 +169,7 @@ EOL translates well to continuous probabilities. ### Single Point Estimates are Problematic -> [!example] p. 232 +> [!example] p. 232 pp. > Hubbard describes a case in the oil industry > where decent estimating is simplified to the point of serious error > (collapsing distributions to a single point for "accounting purposes") @@ -135,20 +177,6 @@ EOL translates well to continuous probabilities. The case closely mirrors construction estimating. -## Mentioned Topics and Abbreviations - -* Analytic Hierarchy Process (AHP) -* Multi-Attribute Utility Theory (MAUT) -* Actuarial Science -* Options Theory (OT) -* Modern Portfolio Theory (MPT) -* Probabalistic Risk Analysis (PRA) -* Value at Risk (VaR) -* Loss-Exceedance Curve (LEC) -* Risk Tolerance -* Certain Monetary Equivalent (CME) - * also called Certainty Equivalent - ## Critiques ### _Exsupero Ursus_