vault backup: 2025-10-13 08:18:22

the-failure-of-risk-management.md

@@ -14,6 +14,20 @@ The Failure of Risk Management
 (Why It's Broken and How to Fix It)
 by Douglas W. 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: ... %%
+
+<!-- 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_