Risk Analysis (and Why You Stink at it)!

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Risk Analysis (and Why You Stink at it)!

  1. 1. The Psychology of RiskThe Psychology of Risk Daniel Crosby, Ph.D. www.doctordanielcrosby.com Daniel@doctordanielcrosby.com (256) 683-5551
  2. 2. You’re terrible at gauging risk!You’re terrible at gauging risk! You’re full of yourself. You’re moody. You don’t have all the facts. You’re a follower. You’re scared of being a loser. You’re a control freak.
  3. 3. You’re full of yourselfYou’re full of yourself  Optimism bias - we tend to believe that we’ll do better than most others engaged in the same activity  BYU therapist study  Cook College - 15% more on positive, 20% less on negative  “Personal Fable”
  4. 4. You’re moodyYou’re moody  Affect heuristic-good feelings lead to lower risk perception  We cannot perceive risk independent of mood  =examine fewer variables, chosen quickly,disregard contradictory info  =“analysis paralysis”, long decision times, inaction
  5. 5. You don’t have all the factsYou don’t have all the facts  Hawaii sharks  Availability heuristic- judgments of the likelihood of future events are made by assessing available info  Botulism vs. Diabetes  More words with “K” as the first or third letter?
  6. 6. Rank from most to least likely Dying in the bath or shower. Victim of a shark attack. Having a stroke. Getting canonized. Attacked by mountain lion. Serious shaving injury. Getting away with murder. Death by flammable nightwear.
  7. 7. Survey says… Murder -1 in 2 Stroke - 1 in 6 Fatal bath - 1 in 2,232 Shaving injury - 1 in 6,585 Saint - 1 in 20 million Nightwear - 1 in 30 million Mountain Lion - 1 in 32 million Shark attack - 1 in 300 million
  8. 8.  The Asch Experiment  Bob the Chess Player and “Risky Shift”  Later referred to as “Group Polarization”  In groups, people become risky with small stakes and more conservative with large stakes You’re a follower
  9. 9. 600 PeopleWith DeadlyVirus A.) If adopted, 200 people will be saved for certain. B.) If adopted, there is a 1/3 chance that 600 people will be saved and a 2/3 chance that none will be saved. C.) If adopted, 400 people will die for certain. D.) If adopted, there is a 1/3 chance that no people will die and a 2/3 chance that 600 will die.
  10. 10. You’re scared of being a loser People are twice as unhappy about a loss as they are pleased by a gain. A over B; 3 to 1. D over C; 4 to 1. People prefer the sure option when the problem is faced as a gain, but prefer the riskier option when the problem is framed as a loss.
  11. 11. You’re a control freakYou’re a control freak  People often treat chance events as if they were skills and therefore under their control  50 lotto tickets - $8.67 for those who chose, $1.96 for no choice  Research shows that people overestimate their control on their organization’s stock
  12. 12. So what do I do?So what do I do? Determine personal risk profile Balance optimism with other viewpoints; realize it can happen to you Don’t shop when you’re “hungry” Gather data from a variety of sources Watch tendency for “groupthink” Don’t let fear of loss stop you or make risky investments to chase losses Understand what is controllable
  13. 13. Perception ofVolatility  Annualized Avg.=10%  US Market SD=20%  Last three years SD=7%  Consider volatility of recent market relative to availability heuristic  August 9, 2007 - DJID drops 387 points, would have been 70 points in early 90’s
  14. 14. Reward for risk  Tradeoffs-bulletproof vests/airplanes  Stocks have returned over 10% annually on average over the last 80 years  Higher returns are your rewards for risk tolerance  Volatility allows for bargains
  15. 15. Risk for the risk-averse Risk and volatility decline over time “Black Monday”, October 19, 1987 - Dow fell 23% in a day, but was up 2% for the year Market loses money in only 1of every 8 five year periods Over 15 year periods, stocks scored positive returns every time
  16. 16. Psychology and investing “You have to work to make money in the stock market.To a small degree, the work entails picking good companies or good mutual funds. But most of the work is enduring the anxiety and fear of owning something that could be worth a good deal less tomorrow than it is today.The challenge is to hang on to good firms through thick and thin.” -James Glassman, Kiplinger

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