ENMG698c - Lecture7 - No Voice Over

Lecture 7
Review of Probability for Risk Management
ENMG 698c: Special Topics - Project Risk Management - Dr. Rayan Khraibani
Copyright © 2020-2021, American University of Beirut, All Rights Reserved

Outline
▪A short-duration project
▪Review of probability theory
▪ Probability
▪ Events
▪ Random variables
▪ Summary statistics
▪Theoretical distributions
2
A Short-Duration Project
3
Context
▪ Each year, a two-day event is organized by the association of students of
AUB
▪ May 2020 theme: The future of graduate engineering education in Lebanon
▪ Panel: Wednesday from 6:00 to 7:30 pm. Important speakers confirmed

their participation
▪ The conference will close with a performance event on Thursday night.
4
Your project
▪ Record the panel and a special performance from a local artist
▪ Sell the DVD as a limited-edition souvenir at the door of the
closing event
5
Feasibility and costs
▪ Hiring the video crew: at least one month in advance. Cost: 1,000$
▪ Editing and recording (6 hours): 400$
▪ Production cost: 200$ plus 0.50$ per DVD burned; if order is for more than
200, 0.40$ per DVD above 200
▪ Royalty costs: 10% of the sales for the local artist
▪ All DVDs that are not sold during the closing event will be destroyed.
6
Feasibility and Costs
▪ Advance registration deadline: two months before the event (very
soon!)
▪ Tickets for the closing event are not included in the registration
package. A 10% discount is offered to participants who reserve in
advance. Tickets are also available at the door (up to capacity)
▪ Attendance data for previous events is available (see data file).

7
Modeling
▪ Objective
▪ Decisions
▪ Parameters
▪ Uncertainty
▪ Risk
8
Probability
9
What is a Probability?
▪ A probability is a measure of an uncertain event
▪ This measure is applied to the “likelihood” of the event
▪ An event which is more likely to happen than another has a higher

probability
▪ By convention, probabilities are between 0 and 1
10
Three Kinds of Probability
▪ Geometric probability
▪ Limit of frequencies
««
▪ Subjective probability ««
11
Consistency
▪ Probabilities should satisfy the probability axioms
▪ Axiom 1: The probability of an event is a real number greater than or equal to
0.
▪ Axiom 2: The probability that at least one of all the possible outcomes of a
process will occur is 1.
▪ Axiom 3: If two events A and B are mutually exclusive, then the probability of
either A or B occurring is the probability of A occurring plus the probability
of B occurring.
12
Probability Tree
high
10%
Attendance
70% medium
20%
low
13
Venn Diagram
Positive
profit
low
medium
high
14
Events
15
Dependent and Independent Events
0,1 0,6
B B
0,2 0,2
NB NB
A A
0,9 0,4
0,7 0,6
NA NA
B B
0,8 0,8
NB NB
0,3 0,4
16
Notation
▪ 𝑃(𝐵|𝐴): Probability that B is realized, given that A is realized
▪ 𝑃(𝐴 ∩ 𝐵): Probability that both A and B are realized
▪ 𝑃(𝐴 ∪ 𝐵): Probability that either A or B is realized
▪ 𝑃 𝐴 ∩ 𝐵 = 𝑃(𝐴) × 𝑃(𝐵|𝐴)
▪ 𝑃 𝐴 ∪ 𝐵 = 𝑃 𝐴 + 𝑃 𝐵 − 𝑃(𝐴 ∩ 𝐵)
17
Bayes Formula
𝑃 𝐴∩𝐵 =𝑃 𝐴 ×𝑃 𝐵 𝐴
𝑃 𝐴 ∩ 𝐵 = 𝑃(𝐵) × 𝑃(𝐴|𝐵)
𝑃 𝐴∩𝐵
𝑃 𝐵𝐴 =
𝑃(𝐴)
𝑃(𝐵) × 𝑃(𝐴|𝐵)
𝑃 𝐵𝐴 =
𝑃(𝐴)
18
Random Variables
19
Random Variables
▪ X: number of points on the die

▪ Probability distribution:
x 1 2 3 4 5 6
P(X=x) 1/6 1/6 1/6 1/6 1/6 1/6
20
Random Variables
Construction costs ($/KW)
▪ X: construction cost
▪ Probability density:
21
Probability Distribution/Density
b
P(a  X  b) = a x b P( X = x i ) =  f (x)dx
i
a
22
Summary Statistics
23
Position indicators
▪Mode
▪Median
▪Mean (μ)
24
Dispersion indicators
▪ Range
▪ Variance (𝜎 2 )
▪ Standard deviation
▪ Interquartile range
25
Risk Indicators
▪ Variance
▪ Semi-variance
▪ Value at risk
TVaR95=9
▪ Tail VaR
95% VaR=7,5
26
Dependency Indicator
▪ Correlation: a measure of linear dependency between two variables, usually
denoted by ρ
Positive correlation, rho=0.93 Negative correlation, rho=-0.35
600 300
500 250
400 200
300 150
200 100
100 50
0 0
0 20 40 60 80 100 120 0 20 40 60 80 100 120
27
Independency and Correlation
No correlation No correlation
120 35
100 30
25
80
20
60
15
40
10
20 5
0 0
0 20 40 60 80 100 120 0 20 40 60 80 100 120
28
Theoretical Distributions
29
▪ Number of equipment failures in a week: Poisson of mean 2
30
▪ Number of producing wells in 100 drillings: Binomial (n=100, p=0.9)
31
▪ Variable production costs: normal with mean of $10 per MW and standard
deviation of 2$ per MW
32
▪ Return on investment: lognormal with mean of $150 and standard deviation
of $150
33
▪ Annual demand for CFC: triangular, minimum 24 tons, probable 30 tons,
maximum 60 tons
34
▪ Delay: uniform between 0 minutes and 5 minutes
35
Exponential Distribution
▪ Time between two machine shut-downs: exponential of mean 10
36
Beta Distribution
• The support of the beta

distribution is the
interval [0,1]
𝛼−1
• Mode:
𝛼+𝛽−2
𝛼
• Mean:
𝛼+𝛽
1
• Variance:
4(2𝛽+1)
37
Assignment
▪ Set up an EXCEL model to evaluate the feasibility and profitability of your
project
▪ Define the risk breakdown structure
▪ Evaluate the sensitivity of the outcome of your projet to various parameters
▪ What additional information would you like to collect?
38

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Lecture 7

Review of Probability for Risk Management

Copyright © 2020-2021, American University of Beirut, All Rights Reserved

▪ May 2020 theme: The future of graduate engineering education in Lebanon

▪ Panel: Wednesday from 6:00 to 7:30 pm. Important speakers confirmed

▪ The conference will close with a performance event on Thursday night.

▪ Record the panel and a special performance from a local artist

▪ Sell the DVD as a limited-edition souvenir at the door of the

▪ Editing and recording (6 hours): 400$

▪ Royalty costs: 10% of the sales for the local artist

▪ Attendance data for previous events is available (see data file).

▪ This measure is applied to the “likelihood” of the event

▪ An event which is more likely to happen than another has a higher

▪ By convention, probabilities are between 0 and 1

▪ 𝑃(𝐴 ∩ 𝐵): Probability that both A and B are realized

▪ 𝑃(𝐴 ∪ 𝐵): Probability that either A or B is realized

▪ X: number of points on the die

Construction costs ($/KW)

• The support of the beta

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