Strategic Risk Taking: A Framework for Risk Management

Chapter 6. Probabilistic Approaches: Scenario Analysis, Decision Trees, and Simulations

In the previous chapter, we examined ways in which we can adjust the value of a risky asset for its risk. Notwithstanding their popularity, all these approaches share a common theme. The riskiness of an asset is encapsulated in one number—a higher discount rate, lower cash flows, or a discount to the value—and the computation almost always requires us to make assumptions (often stringent) about the nature of risk.

In this chapter, we consider a different and potentially more informative way of assessing and presenting the risk in an investment. Rather than compute an expected value for an asset that tries to reflect the different possible outcomes, we can ...