Risky Models
Palisade EMEA
2012 Risk Conference
London
1
© 2012 Captum Capital Limited
Modelling Risk
Estimate probability of future events
Probabilities based on:
Statistical analysis of historic data
Expert opinion
Wisdom of crowds
Subjective best guess
Risk models used to make decisions
2
Subjective Risk Perception
Decision makers:
Have a poor appreciation of probabilities
Are risk averse
Are loss averse
3
US Masters 2012
Sudden Death Play-off
Final 10th Hole – Camilla Par 4
Augusta National
4
10th Hole Playoff
Louis Oosterhuizen (South Africa)
Reached green in 3 shots
15 feet from pin
Bubba Watson (United States)
Reached green in 2 shots
8 feet from pin
5
Bubba Wins!
Oosterhuizen – Bogey 5
Watson – Par 4
6
Toss a coin...
T
H
0.5
7
+
0.5
=
1
Risk Perceptions
1.
2.
0.75
£300
P=1.0
£100
0.25
3.
0.5
0.5
8
£500
- £300
4.
0.25
0.75
- £500
£700
- £100
650 Perceptions
1.
2.
0.75
P=1.0
£300
£100
14%
3.
0.5
26%
£500
4.
0.5
35%
© Dr. Kelvin Stott
9
0.25
0.25
0.75
- £300
26%
- £500
£700
- £100
Loss Aversion
Utility
£100
Loss
Profit
Prospect Theory
- £100
10
Kahneman & Tversky (1974)
Multiple Milestones
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TAMIX Option Value
12
Tamix Option Cash Flow
Year
Cash Flow
0
1
2
3
4
-1.00
0
-12.55
0
157.35
P
NPV
1
0.5
0.5x0.9
-1.00
-10.00
100.00
Cash Flow in £000s
Discount Rate R = 12%
rNPV = -1 + 0.5 x -10 + 0.45 x 100= £39,000,000
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@Risk Option Value
14
TAMIX Model Output
15
What does it mean?
16
rNPV $million)
Probability of
Happening
-1.00
50%
-6.00
5%
39.00
45%
Risk Impact Matrix
Insignificant
Moderate
3
Major
4
Catastrophic
1
Minor
2
1
1
2
3
4
5
Unlikely 2
2
4
6
8
10
Possible 3
3
6
9
12
15
Likely
4
4
8
12
16
20
Certain 5
5
10
15
20
25
Rare
17
5
NHS Risk Assurance
All NHS Trusts are required to have a Risk
Assurance Framework
How useful is it?
Different people assign different risk
probabilities & impacts
Non-quantifiable risks
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NHS Risk Examples
Risk
Rating
Real Risk
Service demand exceeds contract
budget
Likely 4 Impact 5
[Finance Director]
20
25
EWTD limits availability of junior
doctors
Certain 5 Impact 4
[Medical Director]
20
10
Risk
19
The Monty Hall Problem
Originally proposed by:
Steve Selvin in the
American Statistician 1975
Named after:
Monty Hall, host
Let’s Make a Deal
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The Game
 Three doors; one hides a car, the
others hide goats
 You choose one of the 3 doors
 The host opens a door you haven’t
chosen to reveal a goat
 Should you stick with your original
choice – or swap?
21
Monty Hall @ Risk Model
22
The logic of the problem
Stick
Swap
£
0
0
£
0
0
0
£
0
0
£
0
0
0
£
0
0
£
1:3 chance
to win
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2:3 chance
to win
Decision Tree Solution
Player
picks
Door 1
Car
Location
Host Total
opens
P
1/6
Car
Goat
Door
3
1/6
Car
Goat
1
Door
3
1/3
Goat
Car
1
Door
2
1 /3
Goat
Car
Door 1
1/2
Door 3
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Switch
Door
2
1/2
Door 2
Stay
A Controversial Game
A newspaper column received several
thousand complaints about this solution
Experiments show ~80% think there is no
difference between staying or switching
Even after training in probability, ~70% still
choose the wrong answer
25
St Petersburg paradox
Presented the problem and its solution in
Commentaries of the Imperial Academy of
Science of Saint Petersburg (1738)
The problem was invented by Daniel's
cousin Nicolas Bernoulli who first stated it
in a letter to Pierre Raymond de Montmort
of 9 September 1713
Daniel Bernoulli
1700 -1782
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The paradox is a classic problem in
probability and decision theory, based on a
lottery game
The game
You start with £1
A coin is tossed:
Heads – your stake is doubled
Tails – game over
Keep tossing the coin as long it comes up
heads
27
Some plays
Payout
28
1
T
£1
2
H–H-T
£4
3
H–H–H-T
£8
4
H–H–H–H–H-T
£32
What’s the problem?
The Expected Value of the game is unlimited!
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Heads Model
N=0
Head?
No
Yes
N=N+1
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End
1000 Plays
600
500
Average Payout per Play £3.30
400
300
200
100
0
0
1
2
3
# Heads
31
4
5
6
Payout
32
# Heads
0
1
2
% Plays
50
27
12
Payout
£1
£2
£4
3
4
5
6
16
7
2
2
0.5
~0.0002
£8
£16
£32
£64
£65536
Summary
Risk Models depend on Probabilities!
Decision makers:
Have a poor appreciation of probabilities
Are risk averse
Are loss averse
33
About Captum
Innovation in Life Sciences
Licensing
Technology Valuation
Modelling behaviour, innovation, value
See us at
34
Risk Analysis using
Contact
Captum Capital Limited
Michael Brand
e: mjb@captum.com
t: +44 (0) 115 988 6154
m: +44 (0) 7980 257 241
35
Cumberland House
35 Park Row
Nottingham NG1 6EE
United Kingdom
www.captum.com