CHAPTER 4 RISK ANALYSIS

THE ORGANIZATION’S LEVEL OF THE ORGANIZATION’S LEVEL OF SOPHISTICATIONSOPHISTICATION

• The treatment of risk depends on the level of sophistication that an organization achieved in dealing with risks.

• Each organization uses a different approach of risk management which is perceived to lead to increase shareholder value.

• The aim of risk management is to achieve a balanced portfolio of risks that support the company’s objectives & strategies & to ensure it continue to grow & operate stably.

How about you???How about you???•Do attitudes play an important part in risk

management???

•Normally, individuals are governed by their own philosophy, reason & wisdom amassed over their years of experience.

• Individuals’ reaction to risk is based on their perceived level of uncertainty to various outcome.

RISK AND HUMAN BEHAVIORRISK AND HUMAN BEHAVIORAttitudes to RiskAttitudes to Risk

• Individual company’s attitude to risk is defined within the company’s overall objectives & strategies.

•But in making decision, personal feelings, attitudes, experiences & other emotional factors do have a great influence on risk manager in managing risk.

•Discussion can be done but ultimately, it is the financial consideration that determines an agreement on whether a risk is worth taking or not.

Risk Taker vs. Risk AverseRisk Taker vs. Risk Averse• Risk taker - someone who risks

loss or injury in the hope of gain or excitement. E.g. a gambler.

Risk averse - a strong disinclination to take risks.

• In a risky situation, a RA decision maker’s attitude is one of trying to play safe while RT will decide on the option that will either bring in the highest return or the possibility of loss.

•To explore various attitudes towards risk, it is best explained by categorizing risk events using statistical concept of expected value.

Expected Value (EV)Expected Value (EV)•The expected value of different alternatives is the

sum of each outcome or the weighted payoffs for each alternative based on the probability of each occurrence.

EV = ∑ pixipi = probabilityxi = value of the random variable (the number whose value depends on some likelihood of events happening)

Situations in Decision-MakingSituations in Decision-Making

Types of decision-making situations

• Decision making under certainty

• Decision making under risk

• Decision making under uncertainty

Techniques for Forecasting on Techniques for Forecasting on Accidental LossesAccidental Losses•Forecasting using statistical tools have assisted Risk

Manager in controlling potential losses.

•Pattern of events in the past are indicative of what will happen in the future, & at the same time provide indicators of stability @ change.

• If no change pattern probability analysis

• If change pattern regression analysis

Probability Analysis as a Method of Probability Analysis as a Method of Measuring RiskMeasuring Risk

• Probability theory – concerned with measuring the likelihood that something will happen & making predictions on the basis of the likelihood.

• Probability computation – taking the relative frequency of the expected events for a certain duration occurring in the same stable environment.

•Probability Distribution – A set of events representing all possible outcomes of particular events for each possible outcome, while the sum of all possibilities in probability distribution equals 1.0.

•The Law of Large Numbers▫A theorem that describes the result of performing the

same experiment a large number of times.•E.g, a single roll of a six-sided dice produces one of

the numbers 1, 2, 3, 4, 5, 6, each with equal probability. Therefore, the expected value of a single die roll is

1+2+3+4+5+6 6

= 3.5

•According to the law of large numbers, if a large number of dice are rolled, the average of their values (sometimes called the sample mean) is likely to be close to 3.5, with the accuracy increasing as more dice are rolled.

IDENTIFYING RISKS•A process when an organization recognizes that a

risk exist & systematically & continuously seek to identify the risks & the uncertainties associated with it.

•Ongoing process

•Must be conducted by mutual sharing between all persons either exposed directly with the risks @ not.

•Problems in identifying risks:▫It is not understood what kind of dangers exists▫It is not understood what should be protected▫It is not understood what kind of measures are

possible▫It is not estimated how much damage is sufferred

•Tools in risk identification – Risk Scanning

•Studies the internal & external environment, identifying potential threats @ opportunities through dialogues & discussion.