Describing Risk Variability ■ A Scenario o There are two equally likely outcomes in the first job-$2, 000 for a good sales job and $1,000 for a modestly successful one o The second pays $1, 510 most of the time (99 probability), but you will earn $510 if the company go joes out of business(.01 probability Chapter 5 Slide 16
Chapter 5 Slide 16 Describing Risk ◼ A Scenario ⚫ There are two equally likely outcomes in the first job--$2,000 for a good sales job and $1,000 for a modestly successful one. ⚫ The second pays $1,510 most of the time (.99 probability), but you will earn $510 if the company goes out of business (.01 probability). Variability
Describing Risk Income from sales Jobs Outcome 1 Outcome 2 Expected Probability Income($) Probability Income(S)Income Job 1: commission 5 2000 5 1000 1500 Job 2: Fixed salary 99 1510 01 5101500 Chapter 5 Slide 17
Chapter 5 Slide 17 Income from Sales Jobs Job 1: Commission .5 2000 .5 1000 1500 Job 2: Fixed salary .99 1510 .01 510 1500 Expected Probability Income ($) Probability Income ($) Income Outcome 1 Outcome 2 Describing Risk
Describing Risk Income from sales Jobs ■Job1 Expected Income F(X1)=.5($2000+.5($1000=$1500 ■Job2 Expected Income F(X2)=91510)+1(S50)=1500 Chapter 5 Slide 18
Chapter 5 Slide 18 E(X1 ) =.5($2000) +.5($1000) = $1500 ◼ Job 1 Expected Income E(X2 ) =.99($1510) +.01($510) = $1500 ◼ Job 2 Expected Income Income from Sales Jobs Describing Risk
Describing Risk a While the expected values are the same, the variability is not a Greater variability from expected values signals greater risk ■ Deviation o Difference between expected payoff and actual payoff Chapter 5 Slide 19
Chapter 5 Slide 19 ◼ While the expected values are the same, the variability is not. ◼ Greater variability from expected values signals greater risk. ◼ Deviation ⚫ Difference between expected payoff and actual payoff Describing Risk
Describing Risk Deviations from Expected Income(S) Outcome 1 Deviation Outcome 2 Deviation Job1$2,000 $500 $1,000 $500 Job 2 1.510 10 510 900 Chapter 5 Slide 20
Chapter 5 Slide 20 Deviations from Expected Income ($) Job 1 $2,000 $500 $1,000 -$500 Job 2 1,510 10 510 -900 Outcome 1 Deviation Outcome 2 Deviation Describing Risk