Risky Models            Palisade EMEA            2012 Risk Conference            London1                         © 2012 Ca...
Modelling RiskEstimate probability of future eventsProbabilities based on:    Statistical analysis of historic data    ...
Subjective Risk PerceptionDecision makers:    Have a poor appreciation of probabilities    Are risk averse    Are loss...
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 Wa...
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            ...
650 Perceptions1.                               2.                                                £300            P=1.0   ...
Loss Aversion               Utility                             £100     Loss                    Profit                   ...
Multiple Milestones11
TAMIX Option Value12
Tamix Option Cash FlowYear                       0        1              2   3        4Cash Flow            -1.00         ...
@Risk Option Value14
TAMIX Model Output15
What does it mean?                      Probability of     rNPV $million)                       Happening         -1.00   ...
Risk Impact Matrix             Insignificant   Minor   Moderate   Major   Catastrophic                  1            2    ...
NHS Risk AssuranceAll NHS Trusts are required to have a Risk Assurance FrameworkHow useful is it?     Different people ...
NHS Risk ExamplesRisk                                         Risk                                                     Rea...
The Monty Hall ProblemOriginally proposed by:Steve Selvin in theAmerican Statistician 1975                             Nam...
The Game  Three doors; one hides a car, the   others hide goats  You choose one of the 3 doors  The host opens a door y...
Monty Hall @ Risk Model22
The logic of the problem         Stick                Swap     £      0     0       £        0   0     0      £     0     ...
Decision Tree Solution         Car               Host Total   Stay   SwitchPlayerpicks    Location         opens  PDoor 1 ...
A Controversial GameA newspaper column received several thousand complaints about this solutionExperiments show ~80% thi...
St Petersburg paradox                        Presented the problem and its solution in                        Commentaries...
The gameYou start with £1A coin is tossed:     Heads – your stake is doubled     Tails – game overKeep tossing the co...
Some plays                       Payout     1   T              £1     2   H–H-T          £4     3   H–H–H-T        £8     ...
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     ...
Payout     # Heads   % Plays   Payout        0        50        £1        1        27        £2        2        12        ...
SummaryRisk Models depend on Probabilities!Decision makers:     Have a poor appreciation of probabilities     Are risk...
About Captum                           Innovation in Life Sciences      Licensing                   Technology ValuationMo...
Contact                          Captum Capital Limited                          Cumberland House                         ...
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Risky Models

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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

  1. 1. Risky Models Palisade EMEA 2012 Risk Conference London1 © 2012 Captum Capital Limited
  2. 2. 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
  3. 3. Subjective Risk PerceptionDecision makers: Have a poor appreciation of probabilities Are risk averse Are loss averse3
  4. 4. US Masters 2012 Sudden Death Play-off Final 10th Hole – Camilla Par 4 Augusta National4
  5. 5. 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
  6. 6. Bubba Wins! Oosterhuizen – Bogey 5 Watson – Par 46
  7. 7. Toss a coin... H T 0.5 + 0.5 = 17
  8. 8. 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
  9. 9. 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
  10. 10. Loss Aversion Utility £100 Loss Profit Prospect Theory - £100 Kahneman & Tversky (1974)10
  11. 11. Multiple Milestones11
  12. 12. TAMIX Option Value12
  13. 13. 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
  14. 14. @Risk Option Value14
  15. 15. TAMIX Model Output15
  16. 16. What does it mean? Probability of rNPV $million) Happening -1.00 50% -6.00 5% 39.00 45%16
  17. 17. 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
  18. 18. 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
  19. 19. 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
  20. 20. The Monty Hall ProblemOriginally proposed by:Steve Selvin in theAmerican Statistician 1975 Named after: Monty Hall, host Let’s Make a Deal20
  21. 21. 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
  22. 22. Monty Hall @ Risk Model22
  23. 23. 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
  24. 24. 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
  25. 25. 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
  26. 26. 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
  27. 27. 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
  28. 28. 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
  29. 29. What’s the problem?The Expected Value of the game is unlimited!29
  30. 30. Heads Model N=0 No Head? Yes N=N+1 End30
  31. 31. 1000 Plays 600 500 Average Payout per Play £3.30 400 300 200 100 0 0 1 2 3 4 5 6 # Heads31
  32. 32. 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
  33. 33. SummaryRisk Models depend on Probabilities!Decision makers: Have a poor appreciation of probabilities Are risk averse Are loss averse33
  34. 34. About Captum Innovation in Life Sciences Licensing Technology ValuationModelling behaviour, innovation, value Risk Analysis usingSee us at34
  35. 35. 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

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