Risk: mean, variance, standard deviation, risk aversion, risk neutral, risk lover, optimal search Amy Urbanski
Our world is filled with risks and every day companies must decide which way to go: be a risk averter or be a risk lover. When risk is analyzed appropriately it becomes a huge factor in ensuring success. In the following sections and subsections the definitions are outlined, real world solutions and examples are presented and at the end a short quiz should summarize the entire paper.
Risk is measured using the following: Mean, Variance & Standard Deviation.
Mean-- According to the dictionary, "In statistics, an average of a group of numbers or data points. The mean is obtained by adding them and dividing by the number of numbers in the group." For example-- If you are using a set of numbers-- 4, 5, 7, 8, 9, 9, 18-- The average is 8.57. In the life of an MBA student, it also helps to find your grade! Variance-- In statistics, the variance is a measure of how far a set of numbers are spread out from each other (wikipedia).
var.png
If one experiences a higher variance, there is more uncertainty in the investment. Standard Deviation-- Shows how much variation there is from the average-- see the picture below:
So let's put it all together: You are at the casino and you have two choices: $1.00 game or the $10.00 game. The game is selecting one card out of two-- so basically a 50/50 chance. If you draw the Queen you will be paid $1.00, if you choose the Ace, you have to pay $1.00. The value of the game is essentially zero (.5+-.5=0). With a mean of 0 you can then use variance to measure risk. Probability of drawing the Queen*($1.00-expected return)^2+porbability of drawing the Ace * (-1-expected return)^2. So putting the numbers in-- .5(1-0)^2 + .5(-1-0)^2=1. If you do the same for the $10 game, you'll have .5(10-0)^2+.5(-10-0)^2=100.
This shows that the $10.00 game is obviously more risky but using easy calculations shows how Variance can be applied real world and how/why is measures risk.
Types of Risk: Risk Aversion, Risk Neutral, Risk Lover Risk Aversion-- A behavior illustrated by investors and their comforts. The article ( http://www.investors.com/NewsAndAnalysis/Article/586820/201110031835/Risk-Aversion-Has-Economy-Frozen-Stiff.aspx) focuses on types of people who see opportunities differently. It notes that most companies began as startups during tough economies; why is that? Cheaper to hire new workers, better deals for office rent and cheaper to buy supplies. With that being said-- its obviously an much bigger risk because most companies fail during tough times. The confidence or Americans has drastically dropped causing more 'worrywart' type of people and less investing in startups or being involved in something too 'risky.' A classmate passed on another article:http://www.businessday.co.za/articles/Content.aspx?id=157426 which I began to notice in the most recent years when the economy began to fall-- as one countries currency began to fall in value, another country benefitted while others tanked with it-- it just depends how the country is being run and what types of risks it took.
On a personal note-- my husband is very much in the group of people who guarantee return and only then will invest. We have been talking about purchasing a second home to renovate and let my brother move in to and rent. It's a big decision-- what area of Indianapolis, if we buy granite, will we see the return and the biggest-- if we are looking to sell, what kind of market will it do well in? Risk Aversion I think is what brings people together and tears people apart.
Risk Lover-- There is always some type of tradeoff when investing and a risk loving type of investor will spring for something than is going to be returned in a form less than what was paid possibly. This type of investor loves the thrill of the risk-- someone who will choose an option with risk rather than something guaranteed. This person could be the one you see at the casino weekly and even though there are other ways to invest/spend money- they prefer the risk. (financial dictionary.com)
Optimal Search: Helps to find the optimal path and produce the best product by searching for it. The best upcoming example of investment can be seen in Black Friday. If you know that one store has a TV for $100, but you know you're going to have to fight through the crowds and get up early; but you find one that is $135 somehwere else-- what is the real worth and would you continue to search for a better price or accept wherever you are. Another great ongoing example of the Optimal Search is someone who constantly uses Craig's List. During class on 11/14/11 we discussed several sample problems for Optimal Search. If you have a one-third chance of getting a TV for $300, a one-third chance of getting one for $200 and a one-third chance to get a TV for $185, would you accept a TV for $200? (1/3)300+(1/3)200+(1/3)185=228.34. The TV for $200 is a good deal in the market however if it cost more than that $228.34, it may be a better idea to continue the search.
Questions:
1. Which project below infers the highest degree of risk?
a. A mean of 15,000
b. A standard deviation of 8
c. A variance of 100
d. An expected value of 8,500
2. If you are indifferent towards receiving $450 or investing and receiving $450, what type of person would you be classified as?
a. Risk Averse
b. Risk Loving
c. Risk Neutral
d. Risky Business
3. If you are a consumer and a product you have been searching for costs $400 and the expected benefit of continuing the search is $375. Which of the following actions should you take?
a. Discontinue the search and accept the price
b. Bargain with the store manager
c. Continue searching for the cheapest price
d. Find something else to purchase
4. What is the expected value of the following project?
part 1: $350 (50%)
part 2: $275 (35%)
part 3: $500 (15%)
a. $1,125
b. $346.25
c. $258.75
d. $850.25
5. If you have Aplia scores of the following, what is your average?
70%, 35%, 40%, 85%, 90%, 75%, 60%, 50%
a. 63.13%
b. 72.14%
c. 63.75%
d. 56.11%
Answers:
1. c
2. c
3. a
4. b (350*50%)+(275*35%)+(500*15%)= 175+96.25+75=$346.25
5. a (all of the numbers together are 505 and then divide by 8. 505/8=63.13)
Citation: Baye, Michael R. Managerial Economics and Business Strategy. 7th ed. New York: McGraw-Hill, NY.
Financial Dictionary.com. Online. Accessed 10/01/11-11/25/11.
Maake, Moyagabo. Rand Slumps as Risk Aversion Returns. BusinessDay.com. Accessed 10/31/11.
Samuelson, Robert. Risk Aversion has the Economy Frozen Stiff. Written 10/03/2011. Accessed 10/10/2011.
Wei, Zhen. Quantitative Finance. http://zhenwei.wordpress.com/2009/02/08/no-arbitrage-risk-neutral-valuation-and-market-price-of-risk/ Accessed 11/14/11.
Wikipedia.com. Online. Accessed 11/1/11-11/25/11.
Risk Aversion Has the Economy Frozen Stiff
aeroederer
aeroedererOct 10, 2011 9:01 pm
Economist Robert Litan of the Kauffman Foundation likes to recall that half of today's Fortune 500 companies began as startups in a recession or a bear stock market. And why not? During a recession, it's cheaper to hire new workers, rent office space, buy supplies.
But Litan suspects the same process may not be working now. In contrast to earlier slumps, when the number of startups barely fell, there's been a steep decline. From 2006 to 2009, startups dropped 27%.
That's one cause of weak job creation, which depends heavily on startups.
"It's not encouraging," says Litan. "It looks like more risk-aversion."
Americans see themselves as go-getters and risk-takers. Our optimism will ultimately rescue us. So it's said.
But the folklore increasingly collides with reality. The 2008-09 financial crisis traumatized millions. It swelled the ranks of risk-avoiders, worrywarts and victims. Of course, this was mainly a reaction to overborrowing, inflated home values and lost jobs. But now the fear factor is feeding on itself — and it's smothering the recovery.
We are prisoners of our rotten mood. Everywhere, the bias is to spend less and wait to see how things turn out. Just as optimism sustained the boom, pessimism prolongs the bust. This is the reverse of "irrational exuberance," because as long as most people feel this way, the psychology is self-fulfilling. Unfortunately, that's how they feel.
Consider:
Consumers: Confidence surveys show the longest streak of low ratings on record. The Conference Board index, based on people's outlook and buying plans, usually registers between 120 and 140 in good times. The latest reading (August) was 44.5; the low was 25.3 in February 2009.
"We've never seen it drop so low and stay so low," says the Conference Board's Ken Goldstein.
Corporate managers: As is well known, large companies have $2 trillion of cash and securities, up $520 billion since year-end 2007. That's money firms could use to hire and invest in plants or new products — if managers were more confident. Instead, they're stockpiling funds against another financial crisis.
Small-business managers: "These are the most depressed numbers in history," says Holly Wade of the National Federation of Independent Business, whose optimism index started in 1974. Only 11% of firms expect to hire in the next three months. Small companies (500 workers or less) represent half of all employment.
Investors: Stock values reflect low expectations of future profits. Today's P/E is 13.8 for the Standard & Poor's 500 stock index, well below the average of 18 from 1950 to 2011. http://www.investors.com/NewsAndAnalysis/Article/586820/201110031835/Risk-Aversion-Has-Economy-Frozen-Stiff.aspx
Amy Urbanski
Our world is filled with risks and every day companies must decide which way to go: be a risk averter or be a risk lover. When risk is analyzed appropriately it becomes a huge factor in ensuring success. In the following sections and subsections the definitions are outlined, real world solutions and examples are presented and at the end a short quiz should summarize the entire paper.
Risk is measured using the following: Mean, Variance & Standard Deviation.
Mean-- According to the dictionary, "In statistics, an average of a group of numbers or data points. The mean is obtained by adding them and dividing by the number of numbers in the group." For example-- If you are using a set of numbers-- 4, 5, 7, 8, 9, 9, 18-- The average is 8.57. In the life of an MBA student, it also helps to find your grade!Variance-- In statistics, the variance is a measure of how far a set of numbers are spread out from each other (wikipedia).
If one experiences a higher variance, there is more uncertainty in the investment.
Standard Deviation-- Shows how much variation there is from the average-- see the picture below:
http://upload.wikimedia.org/wikipedia/commons/8...iagram.svg
Finding the standard deviation of an investment can help determine how volatile the market is at any given point.
So let's put it all together: You are at the casino and you have two choices: $1.00 game or the $10.00 game. The game is selecting one card out of two-- so basically a 50/50 chance. If you draw the Queen you will be paid $1.00, if you choose the Ace, you have to pay $1.00. The value of the game is essentially zero (.5+-.5=0). With a mean of 0 you can then use variance to measure risk. Probability of drawing the Queen*($1.00-expected return)^2+porbability of drawing the Ace * (-1-expected return)^2. So putting the numbers in-- .5(1-0)^2 + .5(-1-0)^2=1. If you do the same for the $10 game, you'll have .5(10-0)^2+.5(-10-0)^2=100.
This shows that the $10.00 game is obviously more risky but using easy calculations shows how Variance can be applied real world and how/why is measures risk.
Types of Risk: Risk Aversion, Risk Neutral, Risk Lover
Risk Aversion-- A behavior illustrated by investors and their comforts. The article (
http://www.investors.com/NewsAndAnalysis/Article/586820/201110031835/Risk-Aversion-Has-Economy-Frozen-Stiff.aspx) focuses on types of people who see opportunities differently. It notes that most companies began as startups during tough economies; why is that? Cheaper to hire new workers, better deals for office rent and cheaper to buy supplies. With that being said-- its obviously an much bigger risk because most companies fail during tough times. The confidence or Americans has drastically dropped causing more 'worrywart' type of people and less investing in startups or being involved in something too 'risky.' A classmate passed on another article:http://www.businessday.co.za/articles/Content.aspx?id=157426 which I began to notice in the most recent years when the economy began to fall-- as one countries currency began to fall in value, another country benefitted while others tanked with it-- it just depends how the country is being run and what types of risks it took.
On a personal note-- my husband is very much in the group of people who guarantee return and only then will invest. We have been talking about purchasing a second home to renovate and let my brother move in to and rent. It's a big decision-- what area of Indianapolis, if we buy granite, will we see the return and the biggest-- if we are looking to sell, what kind of market will it do well in? Risk Aversion I think is what brings people together and tears people apart.
Risk Neutral-- the behavior between seeking and avoiding risk. This type of person is only concerned with the return that will be received. This article:
http://zhenwei.wordpress.com/2009/02/08/no-arbitrage-risk-neutral-valuation-and-market-price-of-risk/ goes into great detail of the equations that can be used to find returns of investment using different theories.
Risk Lover-- There is always some type of tradeoff when investing and a risk loving type of investor will spring for something than is going to be returned in a form less than what was paid possibly. This type of investor loves the thrill of the risk-- someone who will choose an option with risk rather than something guaranteed. This person could be the one you see at the casino weekly and even though there are other ways to invest/spend money- they prefer the risk. (financial dictionary.com)
Optimal Search: Helps to find the optimal path and produce the best product by searching for it. The best upcoming example of investment can be seen in Black Friday. If you know that one store has a TV for $100, but you know you're going to have to fight through the crowds and get up early; but you find one that is $135 somehwere else-- what is the real worth and would you continue to search for a better price or accept wherever you are. Another great ongoing example of the Optimal Search is someone who constantly uses Craig's List. During class on 11/14/11 we discussed several sample problems for Optimal Search. If you have a one-third chance of getting a TV for $300, a one-third chance of getting one for $200 and a one-third chance to get a TV for $185, would you accept a TV for $200? (1/3)300+(1/3)200+(1/3)185=228.34. The TV for $200 is a good deal in the market however if it cost more than that $228.34, it may be a better idea to continue the search.
Questions:
1. Which project below infers the highest degree of risk?
a. A mean of 15,000
b. A standard deviation of 8
c. A variance of 100
d. An expected value of 8,500
2. If you are indifferent towards receiving $450 or investing and receiving $450, what type of person would you be classified as?
a. Risk Averse
b. Risk Loving
c. Risk Neutral
d. Risky Business
3. If you are a consumer and a product you have been searching for costs $400 and the expected benefit of continuing the search is $375. Which of the following actions should you take?
a. Discontinue the search and accept the price
b. Bargain with the store manager
c. Continue searching for the cheapest price
d. Find something else to purchase
4. What is the expected value of the following project?
part 1: $350 (50%)
part 2: $275 (35%)
part 3: $500 (15%)
a. $1,125
b. $346.25
c. $258.75
d. $850.25
5. If you have Aplia scores of the following, what is your average?
70%, 35%, 40%, 85%, 90%, 75%, 60%, 50%
a. 63.13%
b. 72.14%
c. 63.75%
d. 56.11%
Answers:
1. c
2. c
3. a
4. b (350*50%)+(275*35%)+(500*15%)= 175+96.25+75=$346.25
5. a (all of the numbers together are 505 and then divide by 8. 505/8=63.13)
Citation:
Baye, Michael R. Managerial Economics and Business Strategy. 7th ed. New York: McGraw-Hill, NY.
Financial Dictionary.com. Online. Accessed 10/01/11-11/25/11.
Maake, Moyagabo. Rand Slumps as Risk Aversion Returns. BusinessDay.com. Accessed 10/31/11.
Samuelson, Robert. Risk Aversion has the Economy Frozen Stiff. Written 10/03/2011. Accessed 10/10/2011.
Wei, Zhen. Quantitative Finance. http://zhenwei.wordpress.com/2009/02/08/no-arbitrage-risk-neutral-valuation-and-market-price-of-risk/ Accessed 11/14/11.
Wikipedia.com. Online. Accessed 11/1/11-11/25/11.
Risk Aversion Has the Economy Frozen Stiff
Economist Robert Litan of the Kauffman Foundation likes to recall that half of today's Fortune 500 companies began as startups in a recession or a bear stock market. And why not? During a recession, it's cheaper to hire new workers, rent office space, buy supplies.
But Litan suspects the same process may not be working now. In contrast to earlier slumps, when the number of startups barely fell, there's been a steep decline. From 2006 to 2009, startups dropped 27%.
That's one cause of weak job creation, which depends heavily on startups.
"It's not encouraging," says Litan. "It looks like more risk-aversion."
Americans see themselves as go-getters and risk-takers. Our optimism will ultimately rescue us. So it's said.
But the folklore increasingly collides with reality. The 2008-09 financial crisis traumatized millions. It swelled the ranks of risk-avoiders, worrywarts and victims. Of course, this was mainly a reaction to overborrowing, inflated home values and lost jobs. But now the fear factor is feeding on itself — and it's smothering the recovery.
We are prisoners of our rotten mood. Everywhere, the bias is to spend less and wait to see how things turn out. Just as optimism sustained the boom, pessimism prolongs the bust. This is the reverse of "irrational exuberance," because as long as most people feel this way, the psychology is self-fulfilling. Unfortunately, that's how they feel.
Consider:
Consumers: Confidence surveys show the longest streak of low ratings on record. The Conference Board index, based on people's outlook and buying plans, usually registers between 120 and 140 in good times. The latest reading (August) was 44.5; the low was 25.3 in February 2009.
"We've never seen it drop so low and stay so low," says the Conference Board's Ken Goldstein.
Corporate managers: As is well known, large companies have $2 trillion of cash and securities, up $520 billion since year-end 2007. That's money firms could use to hire and invest in plants or new products — if managers were more confident. Instead, they're stockpiling funds against another financial crisis.
Small-business managers: "These are the most depressed numbers in history," says Holly Wade of the National Federation of Independent Business, whose optimism index started in 1974. Only 11% of firms expect to hire in the next three months. Small companies (500 workers or less) represent half of all employment.
Investors: Stock values reflect low expectations of future profits. Today's P/E is 13.8 for the Standard & Poor's 500 stock index, well below the average of 18 from 1950 to 2011.
http://www.investors.com/NewsAndAnalysis/Article/586820/201110031835/Risk-Aversion-Has-Economy-Frozen-Stiff.aspx