Professor Forman

Background and Motivation

Definition of Risk: UNCERTAIN EVENT that MATTERS

UNCERTAIN: may not happen today, this year, this century or ever

A risk is an event, not a process; it happens or not

MATTERS: Loss (or gain) to OBJECTIVES

The event that matters IS the risk; they are synonyms

Opportunities fit the definition or risk above –they are also events that uncertain and matter,  and some standards organizations such as ISO and PMI consider risks to include opportunities.

However, we prefer to label Opportunities  differently — in a manner that we discuss their certainty equivalents, namely costs and  benefits

OBJECTIVES, which steer us to a best decision, can be categorized as benefits; costs; risks (uncertain costs) and opportunities (uncertain benefits.)

To humans, losses loom larger than gains and hence humans are inherently loss averse.

For example, it might take several compliments to a significant other to offset one criticism.

Kahnerman and Tversky, in their work cited called Prospect Theory, which was cited in Kahneman’s Nobel prize, showed that because the utility curve for losses is steeper than for gains, humans are risk averse when it comes to gains, but risk seeking when it comes to losses.

The significance of this is that humans would rather gamble on risks not occurring rather than invest today’s money/resources in reducing risks that may never happen.

The Mayor of Houston gambled when he refused to invest about $30 million to fix the levies.  The damage from Hurricane Harvey was estimated to be $30 billion.

Bill Gates, in an interview, estimated that it would have cost about $30 billion to plan and reduce risks for the next pandemic, but that $30 billion seemed too much to decision makers.  The estimated financial damage from the Covid-19 virus is estimated to be more than $10 trillion.

The 2019 United States budget for Defense was $686 billion.

Depending on the circumstances, it may or may not be wise to invest money/resources today to reduce risks for events that may never occur, or may not for a long time.  

In order to determine whether an investment to reduce risks for a given circumstance is a good decision, it is necessary to have some estimate of the risks — both long and short term — as well as the costs.

Today, estimating risks is in a comprehensive, scientifically valid process, using both data as well as human judgment is practical.  Such a process can guide a decision making body to arrive at a sound, defensible decision — determining whether or not a ‘stitch in time will save nine‘.



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