Chapter 17 ERA 2.1 Corporate Decision Making Using an Enterprise Risk Model - Don Mango

3 evolutionary steps in decision analysis:
Deterministic \(\Rightarrow\) Risk Analysis \(\Rightarrow\) Certainty Equivalent

  • Argument that 2nd step is sufficient and reasons to move to the 3rd step

  • 4 Benefits of a utility function

Attribute cost back to source of risk for decision making

Decision Making with an Internal Risk Model (IRM)

  1. Quantify corporate risk tolerance and what it is dependent on

    • Spetzler: Benefits of utility curve

    • Walla: Calculates efficient frontier \(\Rightarrow\) Estimate risk tolerance \(\Rightarrow\) Where on the frontier to select the best portfolio based on \(R\), utility curve and CE

  2. Allocating risk capital

  3. Cost benefit analysis with EVA or capital allocation

    • Use a suite of decision metrics that are distinct and independent (to give different perspectives) and are responsive to different dynamics