Risky Models
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Risky Models

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Risk models are a normal part of decision making. ...

Risk models are a normal part of decision making.

This presentation suggests that most people are poor at judging probabilities, and that risk and loss aversion are strong behavioral modifiers which affect decisions.

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Risky Models Risky Models Presentation Transcript

  • Risky Models Palisade EMEA 2012 Risk Conference London1 © 2012 Captum Capital Limited
  • Modelling RiskEstimate probability of future eventsProbabilities based on: Statistical analysis of historic data Expert opinion Wisdom of crowds Subjective best guessRisk models used to make decisions2
  • Subjective Risk PerceptionDecision makers: Have a poor appreciation of probabilities Are risk averse Are loss averse3
  • US Masters 2012 Sudden Death Play-off Final 10th Hole – Camilla Par 4 Augusta National4
  • 10th Hole Playoff Louis Oosterhuizen (South Africa) Reached green in 3 shots 15 feet from pin Bubba Watson (United States) Reached green in 2 shots 8 feet from pin5
  • Bubba Wins! Oosterhuizen – Bogey 5 Watson – Par 46
  • Toss a coin... H T 0.5 + 0.5 = 17
  • Risk Perceptions1. 2. 0.75 £300 P=1.0 £100 0.25 - £5003. 4. £500 £700 0.5 0.25 0.5 0.75 - £100 - £3008
  • 650 Perceptions1. 2. £300 P=1.0 0.75 £100 0.25 14% 26% - £5003. £500 4. £700 0.5 0.25 0.5 0.75 - £300 - £100 35% 26%© Dr. Kelvin Stott9
  • Loss Aversion Utility £100 Loss Profit Prospect Theory - £100 Kahneman & Tversky (1974)10
  • Multiple Milestones11
  • TAMIX Option Value12
  • Tamix Option Cash FlowYear 0 1 2 3 4Cash Flow -1.00 0 -12.55 0 157.35P 1 0.5 0.5x0.9NPV -1.00 -10.00 100.00Cash Flow in £000sDiscount Rate R = 12% rNPV = -1 + 0.5 x -10 + 0.45 x 100= £39,000,00013
  • @Risk Option Value14
  • TAMIX Model Output15
  • What does it mean? Probability of rNPV $million) Happening -1.00 50% -6.00 5% 39.00 45%16
  • Risk Impact Matrix Insignificant Minor Moderate Major Catastrophic 1 2 3 4 5Rare 1 1 2 3 4 5Unlikely 2 2 4 6 8 10Possible 3 3 6 9 12 15Likely 4 4 8 12 16 20Certain 5 5 10 15 20 2517
  • NHS Risk AssuranceAll NHS Trusts are required to have a Risk Assurance FrameworkHow useful is it? Different people assign different risk probabilities & impacts Non-quantifiable risks18
  • NHS Risk ExamplesRisk Risk Real Risk RatingService demand exceeds contractbudget 20 25Likely 4 Impact 5 [Finance Director]EWTD limits availability of juniordoctors 20 10Certain 5 Impact 4 [Medical Director]19
  • The Monty Hall ProblemOriginally proposed by:Steve Selvin in theAmerican Statistician 1975 Named after: Monty Hall, host Let’s Make a Deal20
  • The Game  Three doors; one hides a car, the others hide goats  You choose one of the 3 doors  The host opens a door you haven’t chosen to reveal a goat  Should you stick with your original choice – or swap?21
  • Monty Hall @ Risk Model22
  • The logic of the problem Stick Swap £ 0 0 £ 0 0 0 £ 0 0 £ 0 0 0 £ 0 0 £ 1:3 chance 2:3 chance to win to win23
  • Decision Tree Solution Car Host Total Stay SwitchPlayerpicks Location opens PDoor 1 1/2 Door 1/6 Car Goat 2 Door 1 Door 1/2 1/6 Car Goat 3 1 Door Door 2 1/3 Goat Car 3 1 Door Door 3 1 /3 Goat Car 2 24
  • A Controversial GameA newspaper column received several thousand complaints about this solutionExperiments show ~80% think there is no difference between staying or switchingEven after training in probability, ~70% still choose the wrong answer25
  • St Petersburg paradox Presented the problem and its solution in Commentaries of the Imperial Academy of Science of Saint Petersburg (1738) The problem was invented by Daniels cousin Nicolas Bernoulli who first stated it in a letter to Pierre Raymond de Montmort of 9 September 1713 The paradox is a classic problem in Daniel Bernoulli probability and decision theory, based on a lottery game 1700 -178226
  • The gameYou start with £1A coin is tossed: Heads – your stake is doubled Tails – game overKeep tossing the coin as long it comes up heads27
  • Some plays Payout 1 T £1 2 H–H-T £4 3 H–H–H-T £8 4 H–H–H–H–H-T £3228
  • What’s the problem?The Expected Value of the game is unlimited!29
  • Heads Model N=0 No Head? Yes N=N+1 End30
  • 1000 Plays 600 500 Average Payout per Play £3.30 400 300 200 100 0 0 1 2 3 4 5 6 # Heads31
  • Payout # Heads % Plays Payout 0 50 £1 1 27 £2 2 12 £4 3 7 £8 4 2 £16 5 2 £32 6 0.5 £64 16 ~0.0002 £6553632
  • SummaryRisk Models depend on Probabilities!Decision makers: Have a poor appreciation of probabilities Are risk averse Are loss averse33
  • About Captum Innovation in Life Sciences Licensing Technology ValuationModelling behaviour, innovation, value Risk Analysis usingSee us at34
  • Contact Captum Capital Limited Cumberland House 35 Park RowMichael Brand Nottingham NG1 6EEe: mjb@captum.com United Kingdomt: +44 (0) 115 988 6154m: +44 (0) 7980 257 241 www.captum.com35