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DM: How Much for that Risky Bet in the Window?

March 22, 2010

Now that Spring Break is well and truly done, it’s time for another “What Have I Been Learning In School” update.

The big news from Thursday’s Decision Modeling class is actually what happened before class.  Before we went on our merry way to Spring Break (mine consisted of being at work every day except on weekends, and spending most nights studying) we got a take-home “Quiz” in our Decision Modeling class. 

I’ve loved this class so far, but here I have to take issue with the professor’s use of terminology.  “Quiz” implies a short, easily completed review.  This particular “Quiz”, which was a take-home, happened to roughly coincide with the mid-term period, and happened also to be not short nor easily completed.  Most of it was not overly complicated or difficult, and was a good review of the course material so far, but there was one problem that was particularly vexing.  I’ll get back to that in a moment.

At any rate, I completed this quiz one week prior to its due date, on the day of class Thursday last week.  Then, on Wednesday night, I e-mailed myself all of the various files, Excel spreadsheets, and documents that had answers and supporting material for the questions, so that I could print them and turn them in.  As I opened the files up, with only a few hours remaining (and an hour of that guaranteed to be eaten by my commute to class) I discovered that one of the files did not have the completed answer I had just finished the week before.  And the file in question was the answer for, you guessed it, that one particularly vexing problem.  I fairly quickly realized what happened (and confirmed it after investigating).  I’d worked on the problem at work, during lunch break and a moment of down-time.  As I often do when I am forced to work on things on multiple computers, I e-mailed a copy of the file to myself.  At home, I opened the file from e-mail, finished the job, and saved it down.

Except: Microsoft’s Windows has the terrible penchant for saving files opened from e-mail into a Temporary directory.  Which, of course, makes no sense on this g0d-given-green-earth!  Because if I hit SAVE, I think that is a pretty clear indication that I intend to retrieve what I have saved at a later date.  If it ends up in a temporary directory, and is therefore irretrievable at a future date, well – that pretty much defeats the purpose of my hitting the Save button, doesn’t it?

So, that’s what happened, and in a mad rush I tried to recreate the work I  had done.  Luckily, I had a slightly more recent version of the relevant file on my work computer than what was last really-and-truly-not-just-temporarily-saved on my home computer.  So I’d only lost about an hour or so of work.  I was able to finish the job, get everything printed, and submitted on time.

Once the mid-term was in, class was mostly a review of certain concepts that serve as an introduction to where we’re going next.  We were talking about risk analysis in our modeling and how EMV (expected monetary value) is a fine tool to use if the size of a risky proposition is small relative to our resources.  He calls this the “Billionaire’s Perspective”.  A Billionaire doesn’t really care much if an investment has a 50/50 chance of either making  him $200,000 or costing him $100,000.  Over the long term, making investments like these will average out and earn him $50,000 each.  That’s EMV.  But for the rest of us, it’s not possible to look at things that way.  We have a very low “risk tolerance” because, sure, we’d like to make back $200,000 but we can’t afford the risk of losing $100,000 because we don’t have $100,000 to lose.  So, our models should take our risk tolerance into account.  Doing this involves transforming the values we measure into an “Expected Utility” instead of “Expected Monetary Value”, and then calculating back to our “Certainty Equivalent”, or the certain amount we would value our risk at.

This, he explained, is basically how insurance works: we have a risk that, if whatever it is happens, we can’t afford it.  So, we actually pay some certain amount to an entity that has a Billionaire’s Perspective in order to rid ourselves of the risk.  The insuring entity is able to pool a lot of risk together to get the long-term EMV advantages.  (I could very easily now wax political about this topic but this isn’t the place for that.  If you happened to be really interested in that topic, well, I am willing to share, just not here.)

So, that’s all well and good.  Next class we’re going to learn more about how to figure out the right Risk Tolerance to use in our modeling.

Other than that, nothing interesting to share about writing, the process or writing, or life in general at the moment.  But, as boring as that probably was for some people, for today that’s enough.  See you here same time tomorrow.

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