Chapter 5
•
Describing Risk
o
Probability
the likelihood that a given outcome will occur; can
depend on the nature of the uncertain event, on the beliefs of the
people involved, or both; measures expected value and variability
Objective
relies on the frequency with which certain events tend to
occur
Subjective
the perception that an outcome will occur; may be
based on a person’s judgment or experience, but not necessarily on
the frequency with which a particular outcome has actually
occurred in the past
o
Expected Value
probability weighted average of the payoffs (value
associated with a possible outcome) associated with all possible
outcomes
E(X)=Pr1X1+Pr2X2
o
Variability
the extent to which possible outcomes of an uncertain
event differ
Deviationdifference between expected payoff and actual payoff
Measure variability by calculating standard deviationsquare root
of the weighted average of the squares of the deviations of the
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 Spring '07
 Jones
 Biology, Utility, possible outcomes, certain income

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