What is the risk theory?

Risk theory attempts to explain the decisions that people make when they face uncertainty about the future. Usually, a situation in which risk theory can be applied includes a number of possible states of the world, a number of possible decisions and a result for each combination of status and decisions. The theory predicts the decision according to the division of the results it will bring. The theory is important for people who decide, whose success depends on the way the risks in the world are manifested. For example, people involved in insurance companies whose success depends on the predication of frequency and the size of the demands, using the risk theory to help determine their optimal exposure to risks. In some cases, such as the decision to invest in a company that may fail, uncertainty affects the price the investor is willing to pay. In others, the uncertainty may make a thrust share between whether a person should act at all. These cases are those in which risk theory is used.

The first step in using the risk theory on the situation is to find out what the results are. Every combination of status and decision provides a result according to a function. From a mathematical point of view, the function is called mapping: each point in the graph illustrates possible states and decisions and defines the corresponding point in the graph of the results.

Furthermore, the value must be assigned to each result. As with any theory that attempts to explain individual choices, an important part of the theory of risk of quantification of qualitative conditions is an important part of the theory. In order to compare them to each other, we must assign values ​​to each result. These values ​​that combine all the advantages and disadvantages of each result are called useful values. The Thabsolitic Value of each usefulness value is not important; What matters is the relative value of each of the others, because it determines how much everyone affects the final decision.

Finally, the analyst must assign a probability to each condition. These pRaves are determined by the weight that every result has. Dear results that may arise from each decision are added to bring the overall value for each decision. Theory recommends a decision with the highest total value.

These abstract instructions can be best illustrated with an example. Imagine that you decide between cactus planting or flowers in a window box in front of your kitchen. Relative clotting affects the health of plants. In the wet year, the flowers will flourish and the cacti will also prosper, although not to the same level. He doesn't even do it in a dry year. However, cactive will do significantly better than flowers.

The next step is to assign values ​​the results based on the tool that you get from different boxes in their different states. You may decide that flowers in a humid year will give you use 10, while cacti in a humid year will give eight units of usefulness. In the dry year, the cactus will give you seven units and will give you three flowers. You have to estimate PRava likely to have a wet year and the likelihood of a dry year.

Consider two different probability scenarios. If you think there is 90 % chance of a wet year, then your expected tool from planting flowers is 0.9*10+0.1*3 = 9.3, while your expected tool from planting is 0.9*8+0.1*7 = 7.9. You should plant flowers. However, if the likelihood of a wet year is only 60 percent, then your expected usefulness of flower planting 0.6*10+0.4*3 = 7.2 and your expected usefulness of cacti is 0.6*8+0.4*7 = 7.6. Risk theory will tell you that even if flowers give you the most common benefits, your overall usefulness is best operated by planting cacti.