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Lecture06_student - Whatisrisk Realoptions Afairroulettewheel Youbet$10 Eitheryouwin$10oryoulose$10 .5 Ofcourse,lifeisnotsosimple Thosepes

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    An introduction to risk What is risk? Monte Carlo simulation Real options
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Some risks are easy figure out A “fair” roulette wheel Half of the numbers are red Half of the numbers are black You bet $10 Either you win $10 or you lose $10 Each with probability 0.5
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Of course, life is not so simple Those pesky 0’s In real life, we don’t  necessarily know how many  black numbers there are Same with red and green Are there other colors  besides red, white, and  green?
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How does this metaphor relate  to investments? We come up with our best guesses as  to what the possible outcomes are Sometimes, the best guess is worse  than the actual outcome Sometimes, the opposite occurs
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 in the housing market Banks employ hundreds of “number  crunchers” to try to determine possible  outcome scenarios Many of these employees try to  determine the best- to worst-case  scenarios on mortgage paybacks
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 in the housing market In most cases, the employees  estimating the possible scenarios did  not include the ACTUAL outcome in  their estimates For example, in Las Vegas… …housing prices are down 60% since 2006 …70% of homeowners owe more than their  home is worth Source:  http://firsttuesdayjournal.com/what-happens-in-vegas-does-no , March 2011
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What happened? The Great Recession is something that  has not been seen in the United States  since the 1930s Many people underestimate outcomes  with very low probabilities Most people have difficulty incorporating  low-probability events into cost-benefit  analysis
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Memory is an issue, too! When times are good, people also  forget that at some time in the past,  recessions occurred Smaller housing busts occurred about  20 and 30 years ago Some people analyzing housing markets  have no memory of this occurring
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2006: POP! Source: http://mysite.verizon.net/vzeqrguz/housingbubble/
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In this lecture… …we will look at simple examples to  begin to incorporate risk In reality, if your future job asks you to  determine possible outcomes for an  investment, both really good and really  bad outcomes are possible
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Before moving on… Some products are in fact very  successful Many toys are very risky, but some are  wildly successful Tickle Me Elmo Zhu Zhu pets Cabbage Patch Kids
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Risk of toy sales Many toys are manufactured thousands of  miles away Transportation of these toys often takes  months Orders must be made in anticipation of sales A toy store may have to place its order in July in  anticipation of Christmas season sales
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This note was uploaded on 12/05/2011 for the course ECON 134a taught by Professor Lim during the Fall '08 term at UCSB.

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Lecture06_student - Whatisrisk Realoptions Afairroulettewheel Youbet$10 Eitheryouwin$10oryoulose$10 .5 Ofcourse,lifeisnotsosimple Thosepes

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