Chapter 14

Managerial Decision Making Under Uncertainty

DBA Fall 2023

Managerial Economics Group 22
Dr. Shaima Mahgoub
Group B
Team Members

 Mohammed Fawzy
 Ahmed Abdelkhalek
 Ahmed Magdy
 Amr Elbahnasawy
 Kareem Alaa
 Mohamed Elhussieny
 The Risk Premium
 The risk premium is the maximum amount that a decision maker would pay to avoid the risk ,
Equivalently is the minimum compensation that decision maker take to incur risk.
 The certainty equivalent of a gamble is an amount of money that provides equal utility to the
random payoff of the gamble. The certainty equivalent is less than the expected outcome if
the person is risk averse.

 The risk premium is defined to be the difference between the expected payoff and the
certainty equivalent.

 Risky stock a risk stock is an stock a financial institution owns with a value that may fluctuate
due to changes in interest rates, credit quality, repayment risk, and other factors.
Mini Case
 The values of most stocks is more variable over time than bonds, because stocks are
riskier than bonds

 U.S. government bond is essentially free of any risk, an investor will buy a stock only if
it provides risk premium over a risk of U.S. Government bond

 In 2014 the stocks in standard & Poor’s index of 500 leading stocks had return of 13.5
% which exceed 10.8% return on 10 years

 However stocks not always perform safe than bonds as in year 2008,2011.

 Stocks have had a higher rate of return over longer period, for 50 years 1965-2014 the
average annual return was 11.2% for S&P 500 stocks and 7.1% on long term bonds
 Risk Neutral & Risk Preference
 Risk neutral describes a mindset where
investors focus on potential gains when
making investment decisions.
 A risk averse investor would not consider
the choice to risk a $1000 loss with the
possibility of making a $50 gain to be the
same as risking only $100 to make the same
$50 gain
 Risk preference is how much risk a person is
willing to take based on the expected utility or
satisfaction of the outcome.
 Risk preferences can be broadly categorized into
three types: risk-averse, risk-neutral, and risk-
seeking.
 Risk-averse individuals prefer to avoid risk and
are more likely to choose investments with lower
returns but higher certainty.
 Risk-neutral individuals are indifferent to risk
and make decisions based solely on expected
returns.
 Risk-seeking individuals, on the other hand, are
willing to take on higher levels of risk in pursuit
of higher potential returns.
Mini Case Gambling
 Most of people don’t like risk & purchase insurance as car insurance, medical insurance,..etc.. BUT
many of these same people gambling. If they play repeatedly they are likely to lose money on the
long run.
 According you wall street journal study, internet gamer win 30% of the days they play but only 11%
were in black over two years. The most frequent 10 % players 95% lose money

 Why do people take unfair bets? *Some people risk preferring or because they compulsion to
gamble,*gambling provide entertainment as risk

 One Survey found 65% from Americans they engage in the game

 Instead people gambling because they make mistake as don’t know true probability & some are over
confident, they overestimate the likelihood of winning
 Risk Attitude in Managers

 Risk attitudes exist on a spectrum from risk-aversion (uncomfortable with uncertainty),

through risk tolerant (no strong response), to risk-seeking (welcoming uncertainty). They
are active at individual, group, corporate and national levels, and where they are recognized
their influence on the risk process can be diagnosed and understood.
 Reducing Risks

 mitigating potential losses by reducing the likelihood and severity of a possible loss. For
example, a risk-avoidant investor who is considering investing in oil stocks may decide to avoid
taking a stake in the company because of oil's political and credit risk.

 As Locking your car to prevent steal

 Installing fire alarm to prevent your house to be burned out.

Mini Case Bond Rating
 Correlation and Diversification
 Diversification naturally appeals to the risk-averse creature inside every investor. Betting all your
money on just one horse seems riskier than spreading out your bets on four different horses and it
can be.
 The concept of diversification in investing refers to owning a wide variety of securities across
several asset classes to defray risk.
 Correlation is a statistic that measures the degree to which two variables move in relation to each
other.
 In finance, the correlation can measure the movement of a stock with that of a benchmark index,
such as the S&P 500.
 Combining uncorrelated assets to diversify portfolios allows investors to reduce their exposure to the
risks inherent in certain assets and smooth out fluctuations in their portfolio as a whole. This strategy
enables investors to mitigate risk and therefore generate a more regular and stable performance
 Insurance

 Individual and organizations can reduce risk

by purchasing insurance, in 2015 global
insurance exceed 4.6$ trillion which is more
than 6% of world GDP
 How to Calculate Insurance Premiums
Q&A
Thanks 