Risk concerns the deviation of one or more results A result is the final consequence of a sequence of actions or events expressed qualitatively or quantitatively. Possible results include advantage, disadvantage, gain, injury, loss, value and victory. There may be a range of possible outcomes associated with an event depending on the point of view, historical distance or relevance. Reaching no of one or more future events In probability theory, an event is a set of outcomes to which a probability is assigned. Typically, when the sample space is finite, any subset of the sample space is an event (i.e. all elements of the power set of the sample space are defined as events). However, this approach does not work well in cases where the sample space is infinite, most from their expected value In probability theory and statistics, the expected value of a random variable is the integral of the random variable with respect to its probability measure. Technically, the value of those results may be positive or negative. However, general usage tends to focus only on potential harm that may arise from a future event, which may accrue either from incurring a cost In business, retail, and accounting, a cost is the value of money that has been used up to produce something, and hence is not available for use anymore. In economics, a cost is an alternative that is given up as a result of a decision. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is ("downside risk") or by failing to attain some benefit ("upside risk").

Contents

Historical background

The term risk may be traced back to classical Greek rizikon (Greek ριζα, riza),[citation needed] meaning root, later used in Latin Latin or sometimes Roman is an Italic language originally spoken in Latium and Ancient Rome. Although often considered a dead language, in view of the fact that it has no native, fluent speakers, Latin continues to be taught in schools and has been, and currently is, used in the process of new word production in modern languages from many for "cliff". The term is used in Homer Homer is a legendary ancient Greek epic poet, traditionally said to be the author of the epic poems the Iliad and the Odyssey. The ancient Greeks generally believed that Homer was an historical individual, but most scholars are skeptical: no reliable biographical information has been handed down from classical antiquity, and the poems themselves's Rhapsody M of Odyssey "Sirens, Scylla, Charybdee and the bulls of Helios (Sun)" Odysseus Odysseus or Ulysses (pronounced /juːˈlɪsiːz/; Latin: Ulyssēs, Ulixēs) was a legendary Greek king of Ithaca and the hero of Homer's epic poem the Odyssey. Odysseus also plays a key role in Homer's Iliad and other works in the Epic Cycle tried to save himself from Charybdee at the cliffs of Scylla In Greek mythology, Scylla was a monster that lived on one side of a narrow channel of water, opposite its counterpart Charybdis. The two sides of the strait were within an arrow's range of each other—so close that sailors attempting to avoid Charybdis would pass too close to Scylla and vice versa, where his ship was destroyed by heavy seas generated by Zeus In Greek mythology Zeus is the "Father of Gods and men", according to Hesiod's Theogony, who ruled the Olympians of Mount Olympus as a father ruled the family; he was the god of sky and thunder in Greek mythology. For the Greeks he was the King of the Gods, who oversaw the universe: as Pausanias observed, "That Zeus is king in as a punishment for his crew killing before the bulls of Helios (the god of the sun), by grapping the roots of a wild fig tree.

For the sociologist Niklas Luhmann Niklas Luhmann was a German sociologist, and a prominent thinker in sociological systems theory the term 'risk' is a neologism that appeared with the transition from traditional to modern society.[1]"In the Middle Ages The Middle Ages is a period of European history from the 5th century to the 15th century. The period followed the fall of the Western Roman Empire in 476, and preceded the Early Modern Era. It is the middle period in a three-period division of history: Classical, Medieval, and Modern. The term "Middle Ages" (medium aevum) was coined in the term risicum was used in highly specific contexts, above all sea trade and its ensuing legal problems of loss and damage."[1][2] In the vernacular languages A vernacular, mother tongue or mother language, and less frequently one sense of idiom and dialect, is the native language of a population located in a country or in a region defined on some other basis, such as a locality. For example, Navajo is a local language in the southwest of the United States, and English is the state language of a number of the 16th century the words rischio and riezgo were used,[1] both terms derived from the Arabic word "رزق", "rizk", meaning 'to seek prosperity'. This was introduced to continental Europe, through interaction with Middle Eastern and North African Arab traders. In the English language English is a West Germanic language that arose in the Anglo-Saxon kingdoms of England and spread into South-East Scotland under the influence of the Anglian medieval kingdom of Northumbria. Following the economic, political, military, scientific, cultural, and colonial influence of Great Britain and the United Kingdom from the 18th century, and of the term risk appeared only in the 17th century, and "seems to be imported from continental Europe."[1] When the terminology of risk took ground, it replaced the older notion that thought "in terms of good and bad fortune Luck or fortuity is good or bad fortune in life caused by accident or chance, and attributed by some to reasons of faith or superstition, which happens beyond a person's control."[1] Niklas Luhmann (1996) seeks to explain this transition: "Perhaps, this was simply a loss of plausibility of the old rhetorics of Fortuna Fortuna was the goddess of fortune and personification of luck in Roman religion. She might bring good luck or bad: she could be represented as veiled and blind, as in modern depictions of Justice, and came to represent life's capriciousness. She was also a goddess of fate: as Atrox Fortuna, she claimed the young lives of the princeps Augustus' as an allegorical figure of religious content and of prudentia as a (noble) virtue in the emerging commercial society."[3]

Scenario analysis Scenario analysis can also be used to illuminate "wild cards." For example, analysis of the possibility of the earth being struck by a large celestial object suggests that whilst the probability is low, the damage inflicted is so high that the event is much more important (threatening) than the low probability (in any one year) alone matured during Cold War The Cold War was the continuing state of political conflict, military tension, proxy wars, and economic competition existing after World War II (1939–1945), primarily between the Soviet Union and its satellite states, and the powers of the Western world, particularly the United States. Although the primary participants' military forces never confrontations between major powers A great power is a nation or state that has the ability to exert its influence on a global scale. Great powers characteristically possess economic, military, diplomatic, and cultural strength, which may cause other smaller nations to consider the opinions of great powers before taking actions of their own. International relations theorists have, notably the United States ^ b. English is the de facto language of American government and the sole language spoken at home by 80% of Americans age five and older. Spanish is the second most commonly spoken language and the Soviet Union The Union of Soviet Socialist Republics was a constitutionally socialist state that existed in Eurasia from 1922 to 1991. The name is a translation of the Russian: Союз Советских Социалистических Республик (help·info), tr. Soyuz Sovetskikh Sotsialisticheskikh Respublik, IPA [sɐˈjʊs sɐˈvʲeʦkʲɪx səʦɪ. It became widespread in insurance circles in the 1970s when major oil tanker disasters An oil spill is a release of a liquid petroleum hydrocarbon into the environment due to human activity, and is a form of pollution. The term often refers to marine oil spills, where oil is released into the ocean or coastal waters. Oil spills include releases of crude oil from tankers, offshore platforms, drilling rigs and wells, as well as spills forced a more comprehensive foresight.[citation needed] The scientific approach to risk entered finance in the 1960s with the advent of the capital asset pricing model In finance, the capital asset pricing model is used to determine a theoretically appropriate required rate of return of an asset, if that asset is to be added to an already well-diversified portfolio, given that asset's non-diversifiable risk. The model takes into account the asset's sensitivity to non-diversifiable risk (also known as systematic and became increasingly important in the 1980s when financial derivatives A derivative, in non-financial-expert terms, is an agreement or contract that is not based on a real, or true, exchange, i.e.: There is nothing tangible like money, or a product, that is being exchanged. For example, a person goes to the grocery store, exchanges a currency for a commodity (say, an apple). The exchange is complete, both parties proliferated. It reached general professions in the 1990s when the power of personal computing allowed for widespread data collection and numbers crunching.

Governments are using it, for example, to set standards for environmental regulation Environmental law is a complex and interlocking body of treaties, conventions, statutes, regulations, and common law that, very broadly, operate to regulate the interaction of humanity and the rest of the biophysical or natural environment, toward the purpose of reducing the impacts of human activity, both on the natural environment and on, e.g. "pathway analysis" as practiced by the United States Environmental Protection Agency The U.S. Environmental Protection Agency is an agency of the federal government of the United States charged to protect human health and the environment, by writing and enforcing regulations based on laws passed by Congress. The EPA was proposed by President Richard Nixon and began operation on December 2, 1970, when its establishment was passed.

Definitions of risk

There are different definitions of risk for each of several applications. The widely inconsistent and ambiguous use of the word is one of several current criticisms of the methods to manage risk.[4]

In one definition, "risks" are simply future issues that can be avoided or mitigated, rather than present problems that must be immediately addressed.[5]

In risk management Risk is defined in ISO 31000 as the effect of uncertainty on objectives . Risk management can therefore be considered the identification, assessment, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the, the term "hazard A hazard is a situation that poses a level of threat to life, health, property, or environment. Most hazards are dormant or potential, with only a theoretical risk of harm; however, once a hazard becomes "active", it can create an emergency situation. A hazard does not exist when it is happening. A hazardous situation that has come to" is used to mean an event that could cause harm and the term "risk" is used to mean simply the probability of something happening.

OHSAS (Occupational Health & Safety Advisory Services) defines risk as the product of the probability of a hazard resulting in an adverse event, times the severity of the event.[6] Mathematically, risk often simply defined as:

One of the first major uses of this concept was at the planning of the Delta Works The Delta Works are a series of constructions built between 1950 and 1997 in the southwest of the Netherlands to protect a large area of land around the Rhine-Meuse-Scheldt delta from the sea. The works consist of dams, sluices, locks, dikes, and storm surge barriers. The aim of the dams, sluices, and storm surge barriers was to shorten the Dutch in 1953, a flood protection program in the Netherlands The Netherlands (pronounced /ˈnɛðɚləndz/ ; Dutch: Nederland, pronounced [ˈneːdərlɑnt] ( listen)) is a constituent country of the Kingdom of the Netherlands, located in North-West Europe. It is a parliamentary democratic constitutional monarchy. The Netherlands borders the North Sea to the north and west, Belgium to the south, and Germany, with the aid of the mathematician David van Dantzig David van Dantzig was a Dutch mathematician, well known for the construction in topology of the dyadic solenoid.[7] The kind of risk analysis pioneered here has become common today in fields like nuclear power Nuclear power is produced by controlled nuclear reactions. Commercial and utility plants currently use nuclear fission reactions to heat water to produce steam, which is then used to generate electricity, aerospace Aerospace comprises the atmosphere of Earth and surrounding space. Typically the term is used to refer to the industry that researches, designs, manufactures, operates, and maintains vehicles moving through air and space. Aerospace is a very diverse field, with a multitude of commercial, industrial and military applications and the chemical industry The chemical industry comprises the companies that produce industrial chemicals. It is central to modern world economy, converting raw materials into more than 70,000 different products.

There are many formal methods used to assess or to "measure" risk, which many consider to be a critical factor in human decision making Decision making can be regarded as the mental processes resulting in the selection of a course of action among several alternatives. Every decision making process produces a final choice. The output can be an action or an opinion of choice. Some of these quantitative definitions of risk are well-grounded in sound statistics theory. However, these measurements of risk rely on failure occurrence data which may be sparse. This makes risk assessment difficult in hazardous industries such as nuclear energy where the frequency of failures is rare and harmful consequences of failure are astronomical. The dangerous harmful consequences often necessitate actions to reduce the probability of failure to infinitesimally small values which are hard to measure and corroborate with empirical evidence. Often, the probability Probability is a way of expressing knowledge or belief that an event will occur or has occurred. In mathematics the concept has been given an exact meaning in probability theory, that is used extensively in such areas of study as mathematics, statistics, finance, gambling, science, and philosophy to draw conclusions about the likelihood of of a negative event is estimated by using the frequency of past similar events or by event-tree methods, but probabilities for rare failures may be difficult to estimate if an event tree cannot be formulated. Methods to calculate the cost of the loss of human life vary depending on the purpose of the calculation. Specific methods include what people are willing to pay to insure against death,[8] and radiological release (e.g., GBq of radio-iodine).[citation needed]

Financial risk Financial risk is normally any risk associated with any form of financing. Risk is probability of unfavorable condition; in financial sector it is the probability of actual return being less than expected return. There will be uncertainty in every business; the level of uncertainty present is called risk is often defined as the unexpected variability or volatility In finance, volatility most frequently refers to the standard deviation of the continuously compounded returns of a financial instrument within a specific time horizon. It is used to quantify the risk of the financial instrument over the specified time period. Volatility is normally expressed in annualized terms, and it may either be an absolute of returns and thus includes both potential worse-than-expected as well as better-than-expected returns. References to negative risk below should be read as applying to positive impacts or opportunity (e.g., for "loss" read "loss or gain") unless the context precludes this interpretation.

In statistics, risk is often mapped to the probability of some event seen as undesirable. Usually, the probability of that event and some assessment of its expected harm must be combined into a believable scenario A scenario is a synthetic description of an event or series of actions and events. In the Commedia dell'arte it was an outline of entrances, exits, and action describing the plot of a play that was literally pinned to the back of the scenery. It is also known as canovaccio or "that which is pinned to the canvas" of which the scenery was (an outcome), which combines the set of risk, regret and reward probabilities into an expected value In probability theory and statistics, the expected value of a random variable is the integral of the random variable with respect to its probability measure for that outcome. (See also Expected utility In economics, game theory, and decision theory the expected utility theorem or expected utility hypothesis is a theory of utility in which "betting preferences" of people with regard to uncertain outcomes is represented by a function of the payout (whether in money or other goods), the probability of occurrence, risk aversion, and the.)

Thus, in statistical decision theory Decision theory in Philosophy, mathematics and statistics is concerned with identifying the values, uncertainties and other issues relevant in a given decision, its rationality, and the resulting optimal decision. It is very closely related to the field of game theory, the risk function of an estimator In statistics, an estimator or point estimate is a statistic that is used to infer the value of an unknown parameter in a statistical model. The parameter being estimated is sometimes called the estimand. It can be either finite-dimensional (in parametric and semi-parametric models), or infinite-dimensional (semi-nonparametric and non-parametric δ(x) for a parameter In mathematics, statistics, and the mathematical sciences, a parameter is a quantity that serves to relate functions and variables using a common variable (often t) when such a relationship would be difficult to explicate with an equation. In different contexts the term may have special uses θ, calculated from some observables In physics, particularly in quantum physics, a system observable is a property of the system state that can be determined by some sequence of physical operations. For example, these operations might involve submitting the system to various electromagnetic fields and eventually reading a value off some gauge. In systems governed by classical x, is defined as the expectation value of the loss function In statistics, decision theory and economics, a loss function is a function that maps an event onto a real number representing the economic cost or regret associated with the event L,

In information security Information security means protecting information and information systems from unauthorized access, use, disclosure, disruption, modification or destruction. Mainly the Information Security Consultants are associated with it[citation needed], a risk is written as an asset, the threats to the asset and the vulnerability that can be exploited by the threats to impact the asset - an example being: Our desktop computers (asset) can be compromised by malware (threat) entering the environment as an email attachment (vulnerability).

The risk is then assessed as a function of three variables:

  1. the probability that there is a threat
  2. the probability that there are any vulnerabilities Vulnerability is the susceptibility to physical or emotional injury or attack. It also means to have one's guard down, open to censure or criticism. Vulnerability refers to a person's state of being liable to succumb, as to manipulation, persuasion or temptation
  3. the potential impact to the business.

The two probabilities are sometimes combined and are also known as likelihood. If any of these variables approaches zero, the overall risk approaches zero.

Risk versus uncertainty

Risk: Combination of the likelihood of an occurrence of a hazardous event or exposure(s) and the severity of injury or ill health that can be caused by the event or exposure(s)

In his seminal work Risk, Uncertainty, and Profit, Frank Knight Frank Hyneman Knight was an important economist of the twentieth century. He was born in McLean County, Illinois in a devoutly Christian family of farmers. He never completed high school but was admitted in 1905 to the American University in Tennessee. He graduated in 1911 from Milligan College. At the University of Tennessee he obtained a B.S (1921) established the distinction between risk and uncertainty Uncertainty is a term used in subtly different ways in a number of fields, including philosophy, physics, statistics, economics, finance, insurance, psychology, sociology, engineering, and information science. It applies to predictions of future events, to physical measurements already made, or to the unknown.

“ ... Uncertainty must be taken in a sense radically distinct from the familiar notion of Risk, from which it has never been properly separated. The term "risk," as loosely used in everyday speech and in economic discussion, really covers two things which, functionally at least, in their causal relations to the phenomena of economic organization, are categorically different. ... The essential fact is that "risk" means in some cases a quantity susceptible of measurement, while at other times it is something distinctly not of this character; and there are far-reaching and crucial differences in the bearings of the phenomenon depending on which of the two is really present and operating. ... It will appear that a measurable uncertainty, or "risk" proper, as we shall use the term, is so far different from an unmeasurable one that it is not in effect an uncertainty at all. We ... accordingly restrict the term "uncertainty" to cases of the non-quantitive type.[page needed] ”

Thus, Knightian uncertainty Knightian uncertainty is named after University of Chicago economist Frank Knight , who distinguished risk and uncertainty in his work Risk, Uncertainty, and Profit: is immeasurable, not possible to calculate, while in the Knightian sense risk is measureable.

Another distinction between risk and uncertainty is proposed in How to Measure Anything: Finding the Value of Intangibles in Business and The Failure of Risk Management: Why It's Broken and How to Fix It by Doug Hubbard:[9][10]

Uncertainty: The lack of complete certainty, that is, the existence of more than one possibility. The "true" outcome/state/result/value is not known.
Measurement of uncertainty: A set of probabilities assigned to a set of possibilities. Example: "There is a 60% chance this market will double in five years"
Risk: A state of uncertainty where some of the possibilities involve a loss, catastrophe, or other undesirable outcome.
Measurement of risk: A set of possibilities each with quantified probabilities and quantified losses. Example: "There is a 40% chance the proposed oil well will be dry with a loss of $12 million in exploratory drilling costs".

In this sense, Hubbard uses the terms so that one may have uncertainty without risk but not risk without uncertainty. We can be uncertain about the winner of a contest, but unless we have some personal stake in it, we have no risk. If we bet money on the outcome of the contest, then we have a risk. In both cases there are more than one outcome. The measure of uncertainty refers only to the probabilities assigned to outcomes, while the measure of risk requires both probabilities for outcomes and losses quantified for outcomes.

Risk as a vector quantity

Hubbard also argues that that defining risk as the product of impact and probability presumes (probably incorrectly) that the decision makers are risk neutral.[10] Only for a risk neutral person is the "certain monetary equivalent" exactly equal to the probability of the loss times the amount of the loss. For example, a risk neutral person would consider 20% chance of winning $1 million exactly equal to $200,000 (or a 20% chance of losing $1 million to be exactly equal to losing $200,000). However, most decision makers are not actually risk neutral and would not consider these equivalent choices. This gave rise to Prospect theory and Cumulative prospect theory. Hubbard proposes instead that risk is a kind of "vector quantity" that does not collapse the probability and magnitude of a risk by presuming anything about the risk tolerance of the decision maker. Risks are simply described as an set or function of possible loss amounts each associated with specific probabilities. How this array is collapsed into a single value cannot be done until the risk tolerance of the decision maker is quantified.

Risk can be both negative and positive, but it tends to be the negative side that people focus on. This is because some things can be dangerous, such as putting their own or someone else’s life at risk. Risks concern people as they think that they will have a negative effect on their future.

Insurance and health risk

Insurance is a risk-reducing investment in which the buyer pays a small fixed amount to be protected from a potential large loss. Gambling is a risk-increasing investment, wherein money on hand is risked for a possible large return, but with the possibility of losing it all. Purchasing a lottery ticket is a very risky investment with a high chance of no return and a small chance of a very high return. In contrast, putting money in a bank at a defined rate of interest is a risk-averse action that gives a guaranteed return of a small gain and precludes other investments with possibly higher gain.

Risks in personal health may be reduced by primary prevention actions that decrease early causes of illness or by secondary prevention actions after a person has clearly measured clinical signs or symptoms recognized as risk factors. Tertiary prevention reduces the negative impact of an already established disease by restoring function and reducing disease-related complications. Ethical medical practice requires careful discussion of risk factors with individual patients to obtain informed consent for secondary and tertiary prevention efforts, whereas public health efforts in primary prevention require education of the entire population at risk. In each case, careful communication about risk factors, likely outcomes and certainty must distinguish between causal events that must be decreased and associated events that may be merely consequences rather than causes.

Economic risk

Economic risks can be manifested in lower incomes or higher expenditures than expected. The causes can be many, for instance, the hike in the price for raw materials, the lapsing of deadlines for construction of a new operating facility, disruptions in a production process, emergence of a serious competitor on the market, the loss of key personnel, the change of a political regime, or natural disasters.[11]

In business

Means of assessing risk vary widely between professions. Indeed, they may define these professions; for example, a doctor manages medical risk, while a civil engineer manages risk of structural failure. A professional code of ethics is usually focused on risk assessment and mitigation (by the professional on behalf of client, public, society or life in general).

In the workplace, incidental and inherent risks exist. Incidental risks are those that occur naturally in the business but are not part of the core of the business. Inherent risks have a negative effect on the operating profit of the business.

Risk-sensitive industries

Some industries manage risk in a highly quantified and numerate way. These include the nuclear power and aircraft industries, where the possible failure of a complex series of engineered systems could result in highly undesirable outcomes. The usual measure of risk for a class of events is then:

R = probability of the event × C

The total risk is then the sum of the individual class-risks.

In the nuclear industry, consequence is often measured in terms of off-site radiological release, and this is often banded into five or six decade-wide bands.

The risks are evaluated using fault tree/event tree techniques (see safety engineering). Where these risks are low, they are normally considered to be "Broadly Acceptable". A higher level of risk (typically up to 10 to 100 times what is considered Broadly Acceptable) has to be justified against the costs of reducing it further and the possible benefits that make it tolerable—these risks are described as "Tolerable if ALARP". Risks beyond this level are classified as "Intolerable".

The level of risk deemed Broadly Acceptable has been considered by regulatory bodies in various countries—an early attempt by UK government regulator and academic F. R. Farmer used the example of hill-walking and similar activities, which have definable risks that people appear to find acceptable. This resulted in the so-called Farmer Curve of acceptable probability of an event versus its consequence.

The technique as a whole is usually referred to as Probabilistic Risk Assessment (PRA) (or Probabilistic Safety Assessment, PSA). See WASH-1400 for an example of this approach.

In finance

Main article: Financial risk

In finance, risk is the probability that an investment's actual return will be different than expected. This includes the possibility of losing some or all of the original investment. Some regard a calculation of the standard deviation of the historical returns or average returns of a specific investment as providing some historical measure of risk; see modern portfolio theory. Financial risk may be market-dependent, determined by numerous market factors, or operational, resulting from fraudulent behavior (e.g. Bernard Madoff). Recent studies suggest that testosterone level plays a major role in risk taking during financial decisions.[12][13]

In finance, risk has no one definition, but some theorists, notably Ron Dembo, have defined quite general methods to assess risk as an expected after-the-fact level of regret. Such methods have been uniquely successful in limiting interest rate risk in financial markets. Financial markets are considered to be a proving ground for general methods of risk assessment. However, these methods are also hard to understand. The mathematical difficulties interfere with other social goods such as disclosure, valuation and transparency. In particular, it is not always obvious if such financial instruments are "hedging" (purchasing/selling a financial instrument specifically to reduce or cancel out the risk in another investment) or "speculation" (increasing measurable risk and exposing the investor to catastrophic loss in pursuit of very high windfalls that increase expected value).

As regret measures rarely reflect actual human risk-aversion, it is difficult to determine if the outcomes of such transactions will be satisfactory. Risk seeking describes an individual whose utility function's second derivative is positive. Such an individual would willingly (actually pay a premium to) assume all risk in the economy and is hence not likely to exist.

In financial markets, one may need to measure credit risk, information timing and source risk, probability model risk, and legal risk if there are regulatory or civil actions taken as a result of some "investor's regret". Knowing one's risk appetite in conjunction with one's financial well-being are most crucial.

A fundamental idea in finance is the relationship between risk and return (see modern portfolio theory). The greater the potential return one might seek, the greater the risk that one generally assumes. A free market reflects this principle in the pricing of an instrument: strong demand for a safer instrument drives its price higher (and its return proportionately lower), while weak demand for a riskier instrument drives its price lower (and its potential return thereby higher).

"For example, a US Treasury bond is considered to be one of the safest investments and, when compared to a corporate bond, provides a lower rate of return. The reason for this is that a corporation is much more likely to go bankrupt than the U.S. government. Because the risk of investing in a corporate bond is higher, investors are offered a higher rate of return."

The most popular, and also the most vilified lately risk measurement is Value-at-Risk (VaR). There are different types of VaR - Long Term VaR, Marginal VaR, Factor VaR and Shock VaR[14] The latter is used in measuring risk during the extreme market stress conditions.

In public works

In a peer reviewed study of risk in public works projects located in twenty nations on five continents, Flyvbjerg, Holm, and Buhl (2002, 2005) documented high risks for such ventures for both costs[15] and demand.[16] Actual costs of projects were typically higher than estimated costs; cost overruns of 50% were common, overruns above 100% not uncommon. Actual demand was often lower than estimated; demand shortfalls of 25% were common, of 50% not uncommon.

Due to such cost and demand risks, cost-benefit analyses of public works projects have proved to be highly uncertain.

The main causes of cost and demand risks were found to be optimism bias and strategic misrepresentation. Measures identified to mitigate this type of risk are better governance through incentive alignment and the use of reference class forecasting.[17]

In human services

Huge ethical and political issues arise when human beings themselves are seen or treated as 'risks', or when the risk decision making of people who use human services might have an impact on that service. The experience of many people who rely on human services for support is that 'risk' is often used as a reason to prevent them from gaining further independence or fully accessing the community, and that these services are often unnecessarily risk averse.[18]

Risk in psychology

Main articles: Decision theory and Prospect theory

Regret

In decision theory, regret (and anticipation of regret) can play a significant part in decision-making, distinct from risk aversion (preferring the status quo in case one becomes worse off).

Framing

Framing[19] is a fundamental problem with all forms of risk assessment. In particular, because of bounded rationality (our brains get overloaded, so we take mental shortcuts), the risk of extreme events is discounted because the probability is too low to evaluate intuitively. As an example, one of the leading causes of death is road accidents caused by drunk driving—partly because any given driver frames the problem by largely or totally ignoring the risk of a serious or fatal accident.

For instance, an extremely disturbing event (an attack by hijacking, or moral hazards) may be ignored in analysis despite the fact it has occurred and has a nonzero probability. Or, an event that everyone agrees is inevitable may be ruled out of analysis due to greed or an unwillingness to admit that it is believed to be inevitable. These human tendencies for error and wishful thinking often affect even the most rigorous applications of the scientific method and are a major concern of the philosophy of science.

All decision-making under uncertainty must consider cognitive bias, cultural bias, and notational bias: No group of people assessing risk is immune to "groupthink": acceptance of obviously wrong answers simply because it is socially painful to disagree, where there are conflicts of interest. One effective way to solve framing problems in risk assessment or measurement (although some argue that risk cannot be measured, only assessed) is to raise others' fears or personal ideals by way of completeness.[clarification needed How do fears solve the problem, and what does "by way of completeness" mean?]

Neurobiology of Framing

Framing involves other information that affects the outcome of a risky decision. The right prefrontal cortex has been shown to take a more global perspective[20] while greater left prefrontal activity relates to local or focal processing[21]

From the Theory of Leaky Modules[22] McElroy and Seta proposed that they could predictably alter the framing effect by the selective manipulation of regional prefrontal activity with finger tapping or monaural listening.[23] The result was as expected. Rightward tapping or listening had the effect of narrowing attention such that the frame was ignored. This is a practical way of manipulating regional cortical activation to affect risky decisions, especially because directed tapping or listening is easily done.

Fear as intuitive risk assessment

For the time being, people rely on their fear and hesitation to keep them out of the most profoundly unknown circumstances.

In The Gift of Fear, Gavin de Becker argues that "True fear is a gift. It is a survival signal that sounds only in the presence of danger. Yet unwarranted fear has assumed a power over us that it holds over no other creature on Earth. It need not be this way."

Risk could be said to be the way we collectively measure and share this "true fear"—a fusion of rational doubt, irrational fear, and a set of unquantified biases from our own experience.

The field of behavioral finance focuses on human risk-aversion, asymmetric regret, and other ways that human financial behavior varies from what analysts call "rational". Risk in that case is the degree of uncertainty associated with a return on an asset.

Recognizing and respecting the irrational influences on human decision making may do much to reduce disasters caused by naive risk assessments that pretend to rationality but in fact merely fuse many shared biases together.

Risk assessment and management

Main articles: Risk assessment and Operational risk management

Because planned actions are subject to large cost and benefit risks, proper risk assessment and risk management for such actions are crucial to making them successful.[24]

Since Risk assessment and management is essential in security management, both are tightly related. Security assessment methodologies like CRAMM contain risk assessment modules as an important part of the first steps of the methodology. On the other hand, Risk Assessment methodologies, like Mehari evolved to become Security Assessment methodologies. A ISO standard on risk management (Principles and guidelines on implementation) is currently being draft under code ISO 31000. Target publication date 30 May 2009.

Risk in auditing

The audit risk model expresses the risk of an auditor providing an inappropriate opinion of a commercial entity's financial statements. It can be analytically expressed as:

AR = IR x CR x DR

Where AR is audit risk, IR is inherent risk, CR is control risk and DR is detection risk.

See also

References

  1. ^ a b c d e Luhmann 1996:3
  2. ^ James Franklin, 2001: The Science of Conjecture: Evidence and Probability Before Pascal, Baltimore: Johns Hopkins University Press, 274
  3. ^ Luhmann 1996:4
  4. ^ Douglas Hubbard The Failure of Risk Management: Why It's Broken and How to Fix It, John Wiley & Sons, 2009
  5. ^ E.g. "Risk is the unwanted subset of a set of uncertain outcomes." (Cornelius Keating)
  6. ^ "Risk is a combination of the likelihood of an occurrence of a hazardous event or exposure(s) and the severity of injury or ill health that can be caused by the event or exposure(s)" (OHSAS 18001:2007).
  7. ^ Wired Magazine, Before the levees break, page 3
  8. ^ Landsburg, Steven (2003-03-03). "Is your life worth $10 million?". Everyday Economics (Slate). http://www.slate.com/id/2079475/. Retrieved 2008-03-17.
  9. ^ Douglas Hubbard "How to Measure Anything: Finding the Value of Intangibles in Business" pg. 46, John Wiley & Sons, 2007
  10. ^ a b Douglas Hubbard "The Failure of Risk Management: Why It's Broken and How to Fix It, John Wiley & Sons, 2009
  11. ^ [1]
  12. ^ Sapienza P., Zingales L. and Maestripieri D. 2009. Gender differences in financial risk aversion and career choices are affected by testosterone. Proceedings of the National Academy of Sciences.
  13. ^ Apicella C. L. and all. Testosterone and financial risk preferences. Evolution and Human Behavior. Vol 29. Issue 6. 384-390.abstract
  14. ^ Value at risk
  15. ^ http://flyvbjerg.plan.aau.dk/JAPAASPUBLISHED.pdf
  16. ^ http://flyvbjerg.plan.aau.dk/Traffic91PRINTJAPA.pdf
  17. ^ http://flyvbjerg.plan.aau.dk/0406DfT-UK%20OptBiasASPUBL.pdf
  18. ^ A person centred approach to risk - Risk - Advice on Personalisation - Personalisation - Homepage - CSIP Networks
  19. ^ Amos Tversky / Daniel Kahneman, 1981. "The Framing of Decisions and the Psychology of Choice."[verification needed]
  20. ^ Schatz, J., Craft, S., Koby, M., & DeBaun, M. R. (2004). Asymmetries in visual-spatial processing following childhood stroke. Neuropsychology, 18, 340-352.
  21. ^ Volberg, G., & Hubner, R. (2004). On the role of response conflicts and stimulus position for hemispheric differences in global/local processing: An ERP study. Neuropsychologia, 42, 1805-1813.
  22. ^ Drake, R. A. (2004). Selective potentiation of proximal processes: Neurobiological mechanisms for spread of activation. Medical Science Monitor, 10, 231-234.
  23. ^ McElroy, T., & Seta, J. J. (2004). On the other hand am I rational? Hemisphere activation and the framing effect. Brain and Cognition, 55, 572-580.
  24. ^ Flyvbjerg 2006

Bibliography

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