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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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