BE 300 Final Cheat Sheet.pdf – RISK & UNCERTAINTYManaging Risk more variance, less desirable mitigate: reduce risk exposure or transfer EV of uncertain | Course Hero

RISK & UNCERTAINTY

Managing Risk

more variance, less desirable mitigate: reduce risk exposure or transfer EV of uncertain outcome

= Σp

i

W

i

, where p = probability and W = value of one outcome

Risk Attitudes

neutral pay actuarially fair or less, indi±erent with

variability (only care about highest EV) averse pay premium and likely more (don’t know how much more), care about variability and EV

loving pay EV or less, prefers uncertainty over certain if options have same EV

FAILURES IN FRANCHISING

Risk and Value of Info

WTP for extra info = EV pro²ts w/ full info – EV pro²ts w/o full info; If have full info, will make pro²ts with option that has highest value

ASYMMETRIC INFO

Adverse Selection

Occurs when 1 party is better informed about

risks or quality than the other

and

before parties sign a contract or make an agreement

Death Spiral

As premium rises, relatively healthy want to leave. This makes premium rise

more and pool of existing insured get more expensive. And cycle continues.

Market

Failure

Party with less info (can be buyer or seller) has to base WTP or SP on average

quality risk. Over time, quality of goods for sale goes down, risk in pool goes up, prices

respond accordingly causing market to collapse Lemons Asymmetric info means that

quality is worse than it would be w/ complete info – bad drives out good; DWL – Sellers of