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BUS404: Risk Management

Unit 3: Risk Attitudes and Expected Utility Theory   The previous unit introduced the most commonly used ways in which we measure risk and uncertainty.  It is important to understand that these measures are usually misunderstood, misused and misapplied.  Whenever we look into risks, risk measures, and risk management, we must always view these in a greater context. In this unit, we focus on the risk within the “satisfaction” value maximization for individual and firms. The value here is measured by economists by comparing levels of satisfaction an individual achieves when confronted with two or more choices.

Unit 3 Time Advisory
This unit should take you approximately 10 hours to complete.

      Subunit 3.1: 2 hours
      Subunit 3.2: 2 hours
      Subunit 3.3: 2 hours
      Subunit 3.4: 2 hours
      Subunit 3.5: 2 hours

Unit3 Learning Outcomes
Upon completion of this unit, students will be able to:
- Discuss the economic concept of utility theory. - Understand assumptions that underlie individual preferences, which can then be mapped onto a utility “function,” reflecting the satisfaction level associated with individuals’ preferences. - Explore how individuals maximize utility (or satisfaction). - Understand that an individual’s objective is to maximize expected utility when making decisions under uncertainty. - Understand that people are risk averse, risk neutral, or risk seeking.

3.1 Utility Theory   - Reading: Risk Management for Enterprises and Individuals: “Chapter 3: Risk Attitudes: Expected Utility Theory and Demand for Hedging:” “Section 3.1: Utility Theory”  Link: Risk Management for Enterprises and Individuals:“Chapter 3: Risk Attitudes: Expected Utility Theory and Demand for Hedging:” “Section 3.1: Utility Theory” (HTML)
 
Instructions: Please click on the link above, and read Section 3.1 in its entirety.  Also, complete the Discussion questions at the end of the reading.  This reading introduces Utility Theory, which is a preference-based approach to ranking choices.
 
Reading, note-taking, and answering the Discussion questions should take approximately 2 hours to complete.

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3.2 Uncertainty, Expected Value, and Fair Games   - Reading: Risk Management for Enterprises and Individuals: “Chapter 3: Risk Attitudes: Expected Utility Theory and Demand for Hedging:” “Section 3.2: Uncertainty, Expected Value, and Fair Games” Link: Risk Management for Enterprises and Individuals: “Chapter 3: Risk Attitudes: Expected Utility Theory and Demand for Hedging:” “Section 3.2: Uncertainty, Expected Value, and Fair Games” (HTML)
 
Instructions: Please click on the link above, and read Section 3.2 in its entirety.  Also, complete the Discussion questions at the end of the reading.  This reading explains how to calculate expected values, which are critical in risk management evaluations. 
 
Reading, note-taking, and answering the Discussion questions should take approximately 2 hours to complete.
 
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3.3 Choice under Uncertainty: Expected Utility Theory   - Reading: Risk Management for Enterprises and Individuals: “Chapter 3: Risk Attitudes: Expected Utility Theory and Demand for Hedging:” “Section 3.3: Choice under Uncertainty: Expected Utility Theory” Link: Risk Management for Enterprises and Individuals: “Chapter 3: Risk Attitudes: Expected Utility Theory and Demand for Hedging:” “Section 3.3: Choice under Uncertainty: Expected Utility Theory” (HTML)
 
Instructions: Please click on the link above, and read Section 3.3 in its entirety to learn how to use the Expected Utility Theory to evaluate the outcomes of decisions.  Also, complete the Discussion questions at the end of the reading. 
 
Reading, note-taking, and answering the Discussion questions should take approximately 2 hours to complete.

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3.4 Biases Affecting Choice under Uncertainty   - Reading: Risk Management for Enterprises and Individuals:“Chapter 3: Risk Attitudes: Expected Utility Theory and Demand for Hedging:” “Section 3.4: Biases Affecting Choice under Uncertainty” Link: Risk Management for Enterprises and Individuals:“Chapter 3: Risk Attitudes: Expected Utility Theory and Demand for Hedging:” “Section 3.4: Biases Affecting Choice under Uncertainty”
 
Instructions: Please click on the link above, and read Section 3.4 in its entirety for an introduction to behavioral economics and potential biases that affect decision-making.  The biases discussed in this section include availability bias, anchoring bias, framing effect, and sunk cost.  Also, complete the Discussion questions at the end of the reading.  Please note that this reading also covers the topics outlined in sub-subunits 3.4.1 and 3.4.2.
 
Reading, note-taking, and answering the Discussion questions should take approximately 2 hours to complete.
 
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3.4.1 Framing Effect   Note: This topic is covered by the reading assigned below subunit 3.4.  Focus on the text below the heading “Framing Effect.”

3.4.2 Availability, Experience, and Anchoring bias   Note: This topic is covered by the reading assigned below subunit 3.4.  Focus on the text below the heading “Availability, Experience, and Anchoring Bias.”

3.5 Risk Aversion and Price of Hedging   - Reading: Risk Management for Enterprises and Individuals: “Chapter 3: Risk Attitudes: Expected Utility Theory and Demand for Hedging:” “Section 3.5: Risk Aversion and Price of Hedging” Link: Risk Management for Enterprises and Individuals: “Chapter 3: Risk Attitudes: Expected Utility Theory and Demand for Hedging:” “Section 3.5: Risk Aversion and Price of Hedging” (HTML)
 
Instructions: Please click on the link above, and read Section 3.5 in its entirety to learn about the connection between risk aversion and insurance premiums.  Also, complete the Discussion questions at the end of the reading. 
 
Reading, note-taking, and answering the Discussion questions should take approximately 2 hours to complete.
 
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Unit 3 Assessments   - Assessment: Oxford University Press: Dominick Salvatore's Managerial Economics in a Global Economy: “Chapter 14:” “Multiple Choice Quiz” Link: Oxford University Press: Dominick Salvatore's Managerial Economics in a Global Economy: “Chapter 14:” “Multiple Choice Quiz” (HTML)

 Instructions: This assessment will test what you have learned so
far for Units 1-3. Please click on the link above, and answer all of
the questions in the Multiple Choice Quiz, except for the last three
questions about auctions.  Click on the “Evaluate Quiz” button at
the bottom of the page, and check your answers against the answer
key.  

 This assessment should take approximately 1 hour to complete.  

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  • Assessment: The Saylor Foundation’s “Assessment for Unit 3” Link: The Saylor Foundation’s “Assessment for Unit 3” (PDF) and “Unit 3 Answer Key” (PDF).
     
    Instructions: Complete this assessment after you finish the readings of Unit 3. Write down your answers before checking with the Answer Key.