02 Jan Utility Theory

Week 3 discussion

Utility Theory

Our Introduction to Risk Management discussion in Week 1 is expanded to the understanding of chapter 3’s Utility Theory. Utility Theory discusses the satisfaction level based on the individual’s amount of risk they are willing to take. In some cases, the risk may be too great and the desired object is avoided (e.g., skydiving), or the satisfaction is too great that no risk management is considered (e.g., buying a lottery ticket). Somewhere in between, the management of risk is usually done by some form of insurance. For example, on a personal level, most drivers will buy auto insurance (actually, it’s required in all states) to hedge against a larger loss – the cost of the vehicle or the medical expenses of injured passengers. On the investment side, investors hedge their risky investments with conservative investments (or through the use of derivative instruments).

Risk management is fully discussed in chapter 4. The identification of a company’s risk profile and the analysis of what risks should be avoided. Risks are managed four ways: avoidance, retention, retention with loss control, and transfer. Provide an example of how the company you work for uses one of these risk management techniques. (if you don’t currently have an employer, you should go online and research risk management tools for companies).