14. Risk and Uncertainty Flashcards
What is the definition of risk?
A situation where there are a number of possible outcomes resulting from a decision or event, that can be estimated from past experience with probabilities assigned to possible events
What is the definition of uncertainty?
Uncertainty is used to describe a situation where it is known that there could be a range of future possible outcomes, but there is no basis on which probabilities can be estimated
What is the general equation for simple probability?
P(event) = No. of ways of achieving an event/ Total number of possible different outcomes
What three ways can probabilities be estimated?
Exactly (certain population), empirically (based on historical data) and subjectively
What is the simple multiplication rule, and when can it be used?
P(A and B) = P(A) x P(B)
Used if A and B are independent
What is the multiplication rule for dependent events?
P(A and B) = P(A) x P(B|A)
What is the simple addition rule, and when can it be used?
P(A or B) = P(A) + P(B)
Used if A and B are mutually exclusive
What does it mean for two events to be mutually exclusive?
The occurrence of one event means that it is not possible for the other event to occur
What is the general addition rule?
P(A or B) = P(A) + P(B) - P(A and B)
What is an expected value?
A long run average - the weighted average of a probability distribution
What is the calculation for expected value?
Sum of (probability x payoff)
What are the limitations of expected values?
Not appropriate for one off decisions, ignore the spread of possible returns and relies of accuracy of probabilities
What does standard deviation show?
The spread of data around the mean
What is the formula for standard deviation for ungrouped data?
Sqrt( Sum of (x - xbar)^2 / n)
What is the formula for standard deviation for a frequency distribution?
Sqrt ( (Sum of fx^2)/(Sum of f) - xbar^2 )
