Requires risk likelihood and impact to be quantified ie assigned a real value

Requires risk likelihood and impact to be quantified

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Requires risk likelihood and impact to be quantified (i.e. assigned a real value) Involves probabilistic and statistical analysis of uncertainty § Probabilistic analysis involves creating a model of the real world using random variables and observing the model outcomes to validate fit with real life data § Statistical analysis involves observing real life outcomes and attempting to construct an underlying probabilistic model
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Managing Risk Quantitative risk analysis techniques Tool or Technique Description Financial analysis Financial analysis includes techniques such as Lifecycle Costing, Return on Investment (ROI), Internal Rate of Return (IRR), Net Present Value (NPV) and Cashflow Analysis. Decision Trees and Expected Monetary Value Decision Trees are a graphical technique, which helps in risk prioritisation and impact analysis through constructing a chain of risk events and calculating the Expected Value of a given risk scenario based on the likelihood of each risk event and the impact cost of the scenario outcome. Expected Value is calculated by multiplying the impact cost of a risk scenario outcome by the product of successive risk probabilities in the chain of risk events making up the scenario. Real Options Analysis Real Options Analysis serves to minimise risk exposure and maximise opportunity by taking into account the ability to delay decisions. It uses a variant of a decision tree where the probabilities of events are allowed to change over time and the most optimal outcome based on the timing of a decision is sought.
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Managing Risk Quantitative risk analysis techniques Tool or Technique Description Utility Theory Utility Theory accounts for the observed behaviour where rational decisions about risk do not align with the predictions based on the highest EMV. The model takes into account the risk appetite in relation to the risk to reward ratio (i.e. risk seeking, risk neutral and risk averse attitudes). Prospect Theory This model presents an alternative to the Utility Theory. Among other differences it accounts for the reversal of risk seeking / risk aversion behaviour when applied to gains and losses. Sensitivity Analysis Uses “what if” scenarios to understand the impact of including and excluding specific risks on the overall risk profile. Force Field Analysis Involves analysis of the strength of opposing driving and restraining forces and their effect on the equilibrium shift of a decision. Simulations Includes Monte Carlo simulation and a recently developed Latin Hypercube simulation.
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Managing Risk Expected Monetary Value (EMV) Example
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Managing Risk Utility Theory Utility is a measure of relative satisfaction A utility function measures an individual’s relative preference for an outcome such as increase in wealth and is defined based on two assumptions: § Non-satiation : increasing wealth is always desirable and utility increases with wealth (i.e. more wealth is preferable to less wealth) § Risk-aversion
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