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either in a huge ﬁnancial success or a colossal ﬁnancial loss, and thus the venture

is very risky. You have a conservatively invested retirement portfolio that you are

considering liquidating and reinvesting in the neighbor’s idea, but you are cautious

and you wonder how to analyze your decision options carefully before commit-

ting your hard-earned money. In the past you have used intuition to make choices,

but now the stakes are extremely high because your neighbor is asking you to

invest the
entire
value of your retirement portfolio. The idea could make you a

multi-millionaire or a penniless pauper at retirement.

Certainly in this situation it is wise to rely on
more
that intuition! Chapters 7 and

8 will describe procedures and tools to analyze the risk in decision outcomes, both

good and bad. As we have stated, this chapter deals with risk by answering ques-

tions related to
what
outcome occurs
if
certain conditions are imposed. In the next

chapter we will discuss a related, but more powerful, method for analyzing risk—

risk proﬁles
. Risk proﬁles are graphical representations of the risk associated with

decision strategies or choices. They make explicit the many possible outcomes of a

complex decision problem, and their estimated probability of occurrence, explicit.

For example, consider the risk associated with the purchase of a one dollar lottery

ticket. There is a very high probability, 99%, that you will
lose
the dollar invested;

there is also a very small probability, 1%, that you will
win
one million dollars. This

risk proﬁle is shown in Exhibit 7.1. Note that the
win
outcome, $999,999, is the $1

million net of your $1 investment for the lottery ticket. Now let’s turn our attention

to classifying models.

Exhibit 7.1
Lottery risk

proﬁle

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