Risk tolerances - Revision history

Tkokotas at 09:59, 17 May 2019

2019-05-17T09:59:29Z

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	When measuring risk and determining acceptable levels for tolerance, it is important that projects are viewed as a portfolio. By taking on multiple projects with uncorrelated or negatively correlated outcomes, a firm builds a portfolio of projects whereby the overall level of risk is lower than what one would perceive by looking at projects individually.		When measuring risk and determining acceptable levels for tolerance, it is important that projects are viewed as a portfolio. By taking on multiple projects with uncorrelated or negatively correlated outcomes, a firm builds a portfolio of projects whereby the overall level of risk is lower than what one would perceive by looking at projects individually.

	~~[[File:avoid.jpg\|350px\|thumb\|right\|'''Figure 3:''' Risk avoiders.]]~~
	~~[[File:gambler.jpg\|350px\|thumb\|right\|'''Figure 4:''' Risk takers.]]~~

	== Company perspective ==		== Company perspective ==

Tkokotas at 12:58, 23 November 2018

2018-11-23T12:58:08Z

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	== References ==		== References ==
	<references />		<references />

			[[Category:Project Management]][[Category:Uncertaity]][[Category:Risk]][[Category:Risk Management]][[Category:Finance]]

Tkokotas at 19:02, 17 November 2018

2018-11-17T19:02:52Z

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			''Developed by Edvinas Zamaratskis''


	Risk tolerance is an amount of risk that a project driven organization can withstand. This element in project management indicates the willingness of organization and it's people to avoid or accept risks. Risk tolerance can be analyzed from three different perspectives: company, project manager, and stakeholder. The company risk tolerance depends on the financial stability and project diversification. A project manager’s risk tolerance is affected by job security and corporate culture. The stakeholder’s risk tolerance is influenced by project objective. The project success depends on agreeable level of risk tolerance and early risk management planning.		Risk tolerance is an amount of risk that a project driven organization can withstand. This element in project management indicates the willingness of organization and it's people to avoid or accept risks. Risk tolerance can be analyzed from three different perspectives: company, project manager, and stakeholder. The company risk tolerance depends on the financial stability and project diversification. A project manager’s risk tolerance is affected by job security and corporate culture. The stakeholder’s risk tolerance is influenced by project objective. The project success depends on agreeable level of risk tolerance and early risk management planning.

Edvinas at 21:36, 2 October 2017

2017-10-02T21:36:58Z

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	Risk tolerance concerns both the probabilities of risk occurrences taking place and the resulting impact of those risks. Tools and techniques have been developed to quantify risks and how the organization risk tolerance weighs against them. One way to determine the risk tolerance, is to ask a decision making entity if it would use the opportunity to make a risky, but potentially profitable investment. The required investment is an amount R. The investment has a 50% chance of success. If it succeeds, it will generate the full amount invested, including the cost of capital, plus that amount again. In other words, the return will be R if the investment is successful. If the investment fails, half the investment will be lost, so the return is minus R/2 (see fig. 1). Note that the expected value of the investment is R/4.		Risk tolerance concerns both the probabilities of risk occurrences taking place and the resulting impact of those risks. Tools and techniques have been developed to quantify risks and how the organization risk tolerance weighs against them. One way to determine the risk tolerance, is to ask a decision making entity if it would use the opportunity to make a risky, but potentially profitable investment. The required investment is an amount R. The investment has a 50% chance of success. If it succeeds, it will generate the full amount invested, including the cost of capital, plus that amount again. In other words, the return will be R if the investment is successful. If the investment fails, half the investment will be lost, so the return is minus R/2 (see fig. 1). Note that the expected value of the investment is R/4.

	If R were very low, most decision makers would want to make the investment. If R were very large, for example, close to the market value of the organization, most decision makers would not take the investment. The risk tolerance is the amount R which will not influence decision makers between making and not making the investment. The results of risk tolerances obtained from different executives within the same organization can vary significantly.<ref>4 http://www.prioritysystem.com/reasons5e.html</ref>		If R were very low, most decision makers would want to make the investment. If R were very large, for example, close to the market value of the organization, most decision makers would not take the investment. The risk tolerance is the amount R which will not influence decision makers between making and not making the investment. The results of risk tolerances obtained from different executives within the same organization can vary significantly.<ref>3 http://www.prioritysystem.com/reasons5e.html</ref>

	== Alternative ways to model and quantify of risk tolerance ==		== Alternative ways to model and quantify of risk tolerance ==
	[[File:matrix.PNG\|350px\|thumb\|right\|'''Figure 2:''' Risk tolerance profile.]]		[[File:matrix.PNG\|350px\|thumb\|right\|'''Figure 2:''' Risk tolerance profile.]]

	Information collected into project risk register during risk assessment process can be used to generate risk tolerance profile (fig. 1). The process begins with the company determining the positive or negative impact it is capable to endure of a probable threat or opportunity. With this information, the risk tolerance line is mapped out. Each risk is plotted according to its probability of occurring, as well as the impact it would have. With this information charted out, the firm can identify the individual risks that lie above the firm’s tolerance level and focus resources towards those. The utility curve is another tool for understanding risk tolerance. A utility curve shown in fig. 2 demonstrates a risk averse decision maker while fig. 3 shows a risk-taker.<ref>3 https://books.google.dk/books/about/The_Project_Management_Question_and_Answ.html?id=XjB30_XPikcC&redir_esc=y</ref>		Information collected into project risk register during risk assessment process can be used to generate risk tolerance profile (fig. 1). The process begins with the company determining the positive or negative impact it is capable to endure of a probable threat or opportunity. With this information, the risk tolerance line is mapped out. Each risk is plotted according to its probability of occurring, as well as the impact it would have. With this information charted out, the firm can identify the individual risks that lie above the firm’s tolerance level and focus resources towards those. The utility curve is another tool for understanding risk tolerance. A utility curve shown in fig. 2 demonstrates a risk averse decision maker while fig. 3 shows a risk-taker.<ref>4 https://books.google.dk/books/about/The_Project_Management_Question_and_Answ.html?id=XjB30_XPikcC&redir_esc=y</ref>

	When measuring risk and determining acceptable levels for tolerance, it is important that projects are viewed as a portfolio. By taking on multiple projects with uncorrelated or negatively correlated outcomes, a firm builds a portfolio of projects whereby the overall level of risk is lower than what one would perceive by looking at projects individually.		When measuring risk and determining acceptable levels for tolerance, it is important that projects are viewed as a portfolio. By taking on multiple projects with uncorrelated or negatively correlated outcomes, a firm builds a portfolio of projects whereby the overall level of risk is lower than what one would perceive by looking at projects individually.

Edvinas at 21:35, 2 October 2017

2017-10-02T21:35:44Z

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	== Big idea ==		== Big idea ==

	In project management, risk tolerance is the measure of the degree of uncertainty that a stakeholder accepts in respect of the project risk assessment. The three major stakeholders are the project organization, the customer or the owner of the project and the project manager. Uncertainties often are intangible, or invisible, therefore stakeholders have different perceptions of what constitutes risk and subsequently its tolerance. Hence these three stakeholder groups rarely have the same view on the possible outcomes of a project. The attitude towards risk tolerance varies depending on risk characteristics and project’s internal and external environment. Therefore, it is important to first define “risk” and “risk tolerance” and how it relates to project management in a technology-driven organization.		In project management, risk tolerance is the measure of the degree of uncertainty that a stakeholder accepts in respect of the project risk assessment. The three major stakeholders are the project organization, the customer or the owner of the project and the project manager. Uncertainties often are intangible, or invisible, therefore stakeholders have different perceptions of what constitutes risk and subsequently its tolerance. Hence these three stakeholder groups rarely have the same view on the possible outcomes of a project. The attitude towards risk tolerance varies depending on risk characteristics and project’s internal and external environment. Therefore, it is important to first define “risk” and “risk tolerance” and how it relates to project management in a technology-driven organization.

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	== Application ==		== Application ==

	Risk tolerance application leads to more efficient use of resources because the project team has a better understanding of how to respond to threats and how to exploit opportunities. It is important to prioritize risks and address the most crucial ones, to know which should be avoided, reduced, transferred or accepted. In the same manner, opportunities can be exploited, enhanced, shared or ignored.		Risk tolerance application leads to more efficient use of resources because the project team has a better understanding of how to respond to threats and how to exploit opportunities. It is important to prioritize risks and address the most crucial ones, to know which should be avoided, reduced, transferred or accepted. In the same manner, opportunities can be exploited, enhanced, shared or ignored.

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	==Determining risk tolerance==		==Determining risk tolerance==
			[[File:function.PNG\|350px\|thumb\|right\|'''Figure 1:''' Risk tolerance calculation method.]]

	One way to determine the risk tolerance, is to ask a decision making entity if it would use the opportunity to make a risky, but potentially profitable investment. The required investment is an amount R. The investment has a 50% chance of success. If it succeeds, it will generate the full amount invested, including the cost of capital, plus that amount again. In other words, the return will be R if the investment is successful. If the investment fails, half the investment will be lost, so the return is minus R/2 (see fig. 1). Note that the expected value of the investment is R/4.		Risk tolerance concerns both the probabilities of risk occurrences taking place and the resulting impact of those risks. Tools and techniques have been developed to quantify risks and how the organization risk tolerance weighs against them. One way to determine the risk tolerance, is to ask a decision making entity if it would use the opportunity to make a risky, but potentially profitable investment. The required investment is an amount R. The investment has a 50% chance of success. If it succeeds, it will generate the full amount invested, including the cost of capital, plus that amount again. In other words, the return will be R if the investment is successful. If the investment fails, half the investment will be lost, so the return is minus R/2 (see fig. 1). Note that the expected value of the investment is R/4.

	~~[[File:function.PNG\|350px\|thumb\|right\|'''Figure 1:''' Risk tolerance calculation method.]]~~		If R were very low, most decision makers would want to make the investment. If R were very large, for example, close to the market value of the organization, most decision makers would not take the investment. The risk tolerance is the amount R which will not influence decision makers between making and not making the investment. The results of risk tolerances obtained from different executives within the same organization can vary significantly.<ref>4 http://www.prioritysystem.com/reasons5e.html</ref>

	If R were very low, most decision makers would want to make the investment. If R were very large, for example, close to the market value of the organization, most decision makers would not take the investment. The risk tolerance is the amount R ~~for~~ which decision makers ~~would just be indifferent~~ between making and not making the investment~~. In other words, the risk tolerance is the value of R for which the certain equivalent of the investment is zero~~. The results of risk tolerances obtained from different executives within the same organization can vary significantly.<ref>4 http://www.prioritysystem.com/reasons5e.html</ref>

	== Alternative ways to model and quantify of risk tolerance ==		== Alternative ways to model and quantify of risk tolerance ==
	[[File:matrix.PNG\|350px\|thumb\|right\|'''Figure 2:''' Risk tolerance profile.]]		[[File:matrix.PNG\|350px\|thumb\|right\|'''Figure 2:''' Risk tolerance profile.]]
	Risk tolerance concerns both the probabilities of risk occurrences taking place and the resulting impact of those risks. Tools and techniques have been developed to quantify risks and how the organization risk tolerance weighs against them. Information collected into project risk register during risk assessment process can be used to generate risk tolerance profile (fig. 1). The process begins with the company determining the positive or negative impact it is capable to endure a probability. With this information, the risk tolerance line is mapped out. Each risk is plotted according to its perceived likelihood of occurring, as well as the impact it would have. With this information charted out, the firm can identify the individual risks that lie above the firm’s tolerance level and focus resources towards those. The utility curve is another tool for understanding risk tolerance. A utility curve shown in fig. 2 demonstrates a risk averse decision maker while fig. 3 shows a risk-taker.<ref>3 https://books.google.dk/books/about/The_Project_Management_Question_and_Answ.html?id=XjB30_XPikcC&redir_esc=y</ref>

	When measuring risk and determining acceptable levels for tolerance, it is important that projects are viewed as a portfolio. By taking on multiple projects with uncorrelated or negatively correlated outcomes, a firm builds a portfolio of projects whereby the overall level of risk is lower than what one would perceive by looking at projects individually~~. This way the project risk can be correlated to investment portfolio theory~~.		Information collected into project risk register during risk assessment process can be used to generate risk tolerance profile (fig. 1). The process begins with the company determining the positive or negative impact it is capable to endure of a probable threat or opportunity. With this information, the risk tolerance line is mapped out. Each risk is plotted according to its probability of occurring, as well as the impact it would have. With this information charted out, the firm can identify the individual risks that lie above the firm’s tolerance level and focus resources towards those. The utility curve is another tool for understanding risk tolerance. A utility curve shown in fig. 2 demonstrates a risk averse decision maker while fig. 3 shows a risk-taker.<ref>3 https://books.google.dk/books/about/The_Project_Management_Question_and_Answ.html?id=XjB30_XPikcC&redir_esc=y</ref>

			When measuring risk and determining acceptable levels for tolerance, it is important that projects are viewed as a portfolio. By taking on multiple projects with uncorrelated or negatively correlated outcomes, a firm builds a portfolio of projects whereby the overall level of risk is lower than what one would perceive by looking at projects individually.

	[[File:avoid.jpg\|350px\|thumb\|right\|'''Figure 3:''' Risk avoiders.]]		[[File:avoid.jpg\|350px\|thumb\|right\|'''Figure 3:''' Risk avoiders.]]
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	The risk tolerance of the project manager and other members of the project team depends on job security and corporate culture. Project manager should have a detailed understanding of the firm’s tolerance level for the possible occurrence of every sizable risk or opportunity. Two categories of risk which concern project manager can be identified. These are project risk and professional risk.		The risk tolerance of the project manager and other members of the project team depends on job security and corporate culture. Project manager should have a detailed understanding of the firm’s tolerance level for the possible occurrence of every sizable risk or opportunity. Two categories of risk which concern project manager can be identified. These are project risk and professional risk.

	Project risk applies to the uncertainties for a project		Project risk applies to the uncertainties for a project manager in achieving a project’s goals in terms of time, cost, and quality. These risks are the main subject of risk management as they apply to project management.
	manager in achieving a project’s goals in terms of time, cost, and quality. These risks are the main subject of risk management as they apply to project
	management.

	Professional risk deals with a project manager’s uncertainties with respect to future job advancement and reward. This type of risk receives less attention, but it can potentially drive a project manager’s decisions and cause those decisions not to be in line with defined risk tolerance levels. Naturally, a project manager weighs credit and blame when making decisions. A project’s visibility and impact heavily influence a project manager’s personal risk tolerance. If the manager possesses a strong drive to climb the corporate ladder, he or she may accept more risk in a highly visible project in an effort to gain accolades should the project come through. In a less visible project, there is less incentive for risk-taking. This can be in contrast with the firm’s risk tolerance profile of a willingness to accept greater risk on smaller projects than larger visible projects.		Professional risk deals with a project manager’s uncertainties with respect to future job advancement and reward. This type of risk receives less attention, but it can potentially drive a project manager’s decisions and cause those decisions not to be in line with defined risk tolerance levels.

	== Stakeholder perspective ==		== Stakeholder perspective ==
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	== Limitation ==		== Limitation ==
	~~As one of the methods limitations it can be mentioned, that because firms~~ have limited resources and various project proposals competing for them, there is
	an ~~embedded incentive~~ for ~~overly~~ optimistic estimates and forecasts. Combined with this, any expression of pessimism ~~is often construed~~ as disloyalty to the organization or the project team. ~~These factors lead to serious concerns over whether the~~ risk tolerance levels ~~are defined correctly. This can~~ lead to projects being delivered late, over budget, under quality, out of scope, and without meeting all the initial goals. Due to to size and complexity, some projects ~~can be plagued~~ be plagued with conflicting tolerances of risks. It is difficult for all project stakeholders to agree on risk tolerance levels throughout the life cycle of the project.		Organizations have limited resources and various project proposals competing for them, there is an inclination for too optimistic estimates and forecasts. Combined with this, any expression of pessimism could be viewed as disloyalty to the organization or the project team. Additionally, incorrectly identified risk tolerance levels could lead to projects being delivered late, over budget, under quality, out of scope, and without meeting all the initial goals. Due to to size and complexity, some projects could be plagued with conflicting tolerances of risks. Finally, tt is difficult for all project stakeholders to agree on risk tolerance levels throughout the life cycle of the project.

	== References ==		== References ==
	<references />		<references />

Edvinas at 21:20, 2 October 2017

2017-10-02T21:20:56Z

← Older revision		Revision as of 21:20, 2 October 2017
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	== Big idea ==		== Big idea ==
	In project management, risk tolerance is the measure of the degree of uncertainty that a stakeholder accepts in respect of the project risk assessment. The three major stakeholders are the project organization, the customer or the owner of the project and the project manager. ~~Risk is~~ intangible, or invisible, therefore stakeholders have different perceptions of what constitutes risk and subsequently its tolerance. Hence these three stakeholder groups rarely have the same view on the possible outcomes of a project. The attitude towards risk tolerance varies depending on risk characteristics and project’s internal and external environment. Therefore, it is important to first define “risk” and “risk tolerance” and how it relates to project management in a technology-driven organization.		In project management, risk tolerance is the measure of the degree of uncertainty that a stakeholder accepts in respect of the project risk assessment. The three major stakeholders are the project organization, the customer or the owner of the project and the project manager. Uncertainties often are intangible, or invisible, therefore stakeholders have different perceptions of what constitutes risk and subsequently its tolerance. Hence these three stakeholder groups rarely have the same view on the possible outcomes of a project. The attitude towards risk tolerance varies depending on risk characteristics and project’s internal and external environment. Therefore, it is important to first define “risk” and “risk tolerance” and how it relates to project management in a technology-driven organization.

	According to classical decision theory, risk is generally understood to be the distribution of possible outcomes, their probability and impact. In project management, this definition can be applied to time, cost, quality, and other factors that can affect these three concerns. It can be concluded, that a risk can either be an opportunity or a threat. An opportunity has positive effect on project objectives, while a threat possess a negative impact. The objective of risk management is to increase the probability of positive risks, and reduce the probability of negative risks.<ref>1 http://www.unnap.com/six-sigma/risk-appetite-tolerance-and-threshold-explained/</ref>		According to classical decision theory, risk is generally understood to be the distribution of possible outcomes, their probability and impact. In project management, this definition can be applied to time, cost, quality, and other factors that can affect these three concerns. It can be concluded, that a risk can either be an opportunity or a threat. An opportunity has positive effect on project objectives, while a threat possess a negative impact. The objective of risk management is to increase the probability of positive risks, and reduce the probability of negative risks.<ref>1 http://www.unnap.com/six-sigma/risk-appetite-tolerance-and-threshold-explained/</ref>
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	Thirdly, it is important for companies to exercise an organizational culture that which promotes calculated risk-taking and innovation. Risk taking should be well thought out and measured. Project managers should be trained to quantify risks. Upper management should lend a hand in getting functional		Thirdly, it is important for companies to exercise an organizational culture that which promotes calculated risk-taking and innovation. Risk taking should be well thought out and measured. Project managers should be trained to quantify risks. Upper management should lend a hand in getting functional
	managers involved in the risk management process to help improve their decision making ability. ~~It is recommended as part of risk training for project managers to ask four questions:~~		managers involved in the risk management process to help improve their decision making ability. By going through these processes, a project manager should improve evaluation of the personal risk tolerance level as well as that of the project team and the company as a whole.

	* Am I a risk-taker or avoider?
	* What about my project sponsor?
	* How much will the project benefit my organization?
	* What is the project team’s experience and expertise?

	By going through ~~the process of addressing~~ these ~~issues~~, a project manager should improve evaluation of the personal risk tolerance level as well as that of the project team and the company as a whole.

	Additionally, comprehensive performance reviews of project managers are another important component for maintaining a shared understanding and vision of		Additionally, comprehensive performance reviews of project managers are another important component for maintaining a shared understanding and vision of
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	opportunities. If the project manager does not receive input from the appropriate representatives of the stakeholder, or the messages are not cohesive, the project performance will suffer and accepted risk levels will not be met.		opportunities. If the project manager does not receive input from the appropriate representatives of the stakeholder, or the messages are not cohesive, the project performance will suffer and accepted risk levels will not be met.

	Finally, in performing risk assessment, decision issuing entity should adopt an outside view. This means that a project manager should ~~make forecasts not only on historical figures and facts pertaining to the project~~ at ~~hand, but more on~~ what has happened with similar scenarios outside of the project and even outside of the organization. By doing so, there is less chance the project manager will make overly optimistic forecasts, which lead to failed projects. Project risk tolerance is a crucial part of any risk management plan. Risk tolerance should be analyzed continuously during the life cycle of the project.		Finally, in performing risk assessment, decision issuing entity should adopt an outside view. This means that a project manager should look at what has happened with similar scenarios outside of the project and even outside of the organization. By doing so, there is less chance the project manager will make overly optimistic forecasts, which lead to failed projects. Project risk tolerance is a crucial part of any risk management plan. Risk tolerance should be analyzed continuously during the life cycle of the project.

	==Determining risk tolerance==		==Determining risk tolerance==

	~~There are several ways~~ to determine the risk tolerance ~~for an organization. One~~ is to ask ~~senior~~ decision ~~makers (ideally,~~ the ~~CEO) to answer the following hypothetical question. Suppose you have an~~ opportunity to make a risky, but potentially profitable investment. The required investment is an amount R ~~that, for the moment, is unspecified~~. The investment has a 50~~-50~~ chance of success. If it succeeds, it will generate the full amount invested, including the cost of capital, plus that amount again. In other words, the return will be R if the investment is successful. If the investment fails, half the investment will be lost, so the return is minus R/2. ~~Figure 47 illustrates the opportunity~~. Note that the expected value of the investment is R/4.		One way to determine the risk tolerance, is to ask a decision making entity if it would use the opportunity to make a risky, but potentially profitable investment. The required investment is an amount R. The investment has a 50% chance of success. If it succeeds, it will generate the full amount invested, including the cost of capital, plus that amount again. In other words, the return will be R if the investment is successful. If the investment fails, half the investment will be lost, so the return is minus R/2 (see fig. 1). Note that the expected value of the investment is R/4.

	[[File:function.PNG\|350px\|thumb\|right\|'''Figure 1:''' Risk tolerance calculation method.]]		[[File:function.PNG\|350px\|thumb\|right\|'''Figure 1:''' Risk tolerance calculation method.]]

	If R were very low, most ~~CEOs~~ would want to make the investment. If R were very large, for example, close to the market value of the ~~enterprise~~, most ~~CEOs~~ would not take the investment. The risk tolerance is the amount R for which decision makers would just be indifferent between making and not making the investment. In other words, the risk tolerance is the value of R for which the certain equivalent of the investment is zero.		If R were very low, most decision makers would want to make the investment. If R were very large, for example, close to the market value of the organization, most decision makers would not take the investment. The risk tolerance is the amount R for which decision makers would just be indifferent between making and not making the investment. In other words, the risk tolerance is the value of R for which the certain equivalent of the investment is zero. The results of risk tolerances obtained from different executives within the same organization can vary significantly.<ref>4 http://www.prioritysystem.com/reasons5e.html</ref>
	~~Empirical studies have been conducted to measure organizational risk tolerances~~. The results ~~show that~~ risk tolerances obtained from different executives within the same organization vary tremendously. Generally, those lower in the organization have lower risk tolerances. Howard [9] reports that assessments from CEO's in the oil and chemicals industry concluded that risk tolerance is roughly six per cent of sales, one to one and a half times net income, or one-sixth of equity. McNamee and Celona [10] add to this list a ratio of market value to risk tolerance of one-fifth. They also comment that the ratio of risk tolerance to equity or market value [usually translates best between companies in different industries.
	Once risk tolerance has been established, the certain equivalent for any risky project or project portfolio can be obtained via the utility function. The effect, as illustrated in Figure 44, is to subtract a risk adjustment factor from the expected value (if projects allow you to avoid risks, the effect is to add, rather than subtract, adjustment factors). The risk adjustment depends on the risk tolerance and the amount of risk. If the projects are independent (i.e., their risks are uncorrelated), then the certain equivalent of the project portfolio will be the sum of the certain equivalents of the individual projects. If project risks are correlated, the certain equivalent for the portfolio can be obtained once the distribution of payoffs for the portfolio are computed (accounting for correlations as described above).<ref>4 http://www.prioritysystem.com/reasons5e.html</ref>

	An advantage of this approach is that a single risk tolerance can be established for the organization. Use of the common risk tolerance ensures that risks are treated consistently, thus avoiding the common bias in which greater levels of risk aversion tend to be applied by lower-level managers.
	Note that the method presented in this paper do not guarantee that the outcome of a particular risky decision will be optimal or "good," but only that the decision will be rational in the face of uncertainty and that repeated application of these methods will maximize the decision maker's welfare over the long run.

	== Alternative ways to model and quantify of risk tolerance ==		== Alternative ways to model and quantify of risk tolerance ==
	[[File:matrix.PNG\|350px\|thumb\|right\|'''Figure 1:''' Risk tolerance profile.]]		[[File:matrix.PNG\|350px\|thumb\|right\|'''Figure 2:''' Risk tolerance profile.]]
	Risk tolerance concerns both the probabilities of risk occurrences taking place and the resulting impact of those risks. Tools and techniques have been developed to quantify risks and how the organization risk tolerance weighs against them. Information collected into project risk register during risk assessment process can be used to generate risk tolerance profile (fig. 1). The process begins with the company determining the positive or negative impact it is capable to endure a probability. With this information, the risk tolerance line is mapped out. Each risk is plotted according to its perceived likelihood of occurring, as well as the impact it would have. With this information charted out, the firm can identify the individual risks that lie above the firm’s tolerance level and focus resources towards those. The utility curve is another tool for understanding risk tolerance. A utility curve shown in fig. 2 demonstrates a risk averse decision maker while fig. 3 shows a risk-taker.<ref>3 https://books.google.dk/books/about/The_Project_Management_Question_and_Answ.html?id=XjB30_XPikcC&redir_esc=y</ref>		Risk tolerance concerns both the probabilities of risk occurrences taking place and the resulting impact of those risks. Tools and techniques have been developed to quantify risks and how the organization risk tolerance weighs against them. Information collected into project risk register during risk assessment process can be used to generate risk tolerance profile (fig. 1). The process begins with the company determining the positive or negative impact it is capable to endure a probability. With this information, the risk tolerance line is mapped out. Each risk is plotted according to its perceived likelihood of occurring, as well as the impact it would have. With this information charted out, the firm can identify the individual risks that lie above the firm’s tolerance level and focus resources towards those. The utility curve is another tool for understanding risk tolerance. A utility curve shown in fig. 2 demonstrates a risk averse decision maker while fig. 3 shows a risk-taker.<ref>3 https://books.google.dk/books/about/The_Project_Management_Question_and_Answ.html?id=XjB30_XPikcC&redir_esc=y</ref>

	When measuring risk and determining acceptable levels for tolerance, it is important that projects are viewed as a portfolio. By taking on multiple projects with uncorrelated or negatively correlated outcomes, a firm builds a portfolio of projects whereby the overall level of risk is lower than what one would perceive by looking at projects individually. This way the project risk can be correlated to investment portfolio theory.		When measuring risk and determining acceptable levels for tolerance, it is important that projects are viewed as a portfolio. By taking on multiple projects with uncorrelated or negatively correlated outcomes, a firm builds a portfolio of projects whereby the overall level of risk is lower than what one would perceive by looking at projects individually. This way the project risk can be correlated to investment portfolio theory.

	[[File:avoid.jpg\|350px\|thumb\|right\|'''Figure 2:''' Risk avoiders.]]		[[File:avoid.jpg\|350px\|thumb\|right\|'''Figure 3:''' Risk avoiders.]]
	[[File:gambler.jpg\|350px\|thumb\|right\|'''Figure 3:''' Risk takers.]]		[[File:gambler.jpg\|350px\|thumb\|right\|'''Figure 4:''' Risk takers.]]

	== Company perspective ==		== Company perspective ==

Edvinas at 20:57, 2 October 2017

2017-10-02T20:57:42Z

← Older revision		Revision as of 20:57, 2 October 2017
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	If R were very low, most CEOs would want to make the investment. If R were very large, for example, close to the market value of the enterprise, most CEOs would not take the investment. The risk tolerance is the amount R for which decision makers would just be indifferent between making and not making the investment. In other words, the risk tolerance is the value of R for which the certain equivalent of the investment is zero.		If R were very low, most CEOs would want to make the investment. If R were very large, for example, close to the market value of the enterprise, most CEOs would not take the investment. The risk tolerance is the amount R for which decision makers would just be indifferent between making and not making the investment. In other words, the risk tolerance is the value of R for which the certain equivalent of the investment is zero.
	Empirical studies have been conducted to measure organizational risk tolerances. The results show that risk tolerances obtained from different executives within the same organization vary tremendously. Generally, those lower in the organization have lower risk tolerances. Howard [9] reports that assessments from CEO's in the oil and chemicals industry concluded that risk tolerance is roughly six per cent of sales, one to one and a half times net income, or one-sixth of equity. McNamee and Celona [10] add to this list a ratio of market value to risk tolerance of one-fifth. They also comment that the ratio of risk tolerance to equity or market value [usually translates best between companies in different industries.		Empirical studies have been conducted to measure organizational risk tolerances. The results show that risk tolerances obtained from different executives within the same organization vary tremendously. Generally, those lower in the organization have lower risk tolerances. Howard [9] reports that assessments from CEO's in the oil and chemicals industry concluded that risk tolerance is roughly six per cent of sales, one to one and a half times net income, or one-sixth of equity. McNamee and Celona [10] add to this list a ratio of market value to risk tolerance of one-fifth. They also comment that the ratio of risk tolerance to equity or market value [usually translates best between companies in different industries.
	Once risk tolerance has been established, the certain equivalent for any risky project or project portfolio can be obtained via the utility function. The effect, as illustrated in Figure 44, is to subtract a risk adjustment factor from the expected value (if projects allow you to avoid risks, the effect is to add, rather than subtract, adjustment factors). The risk adjustment depends on the risk tolerance and the amount of risk. If the projects are independent (i.e., their risks are uncorrelated), then the certain equivalent of the project portfolio will be the sum of the certain equivalents of the individual projects. If project risks are correlated, the certain equivalent for the portfolio can be obtained once the distribution of payoffs for the portfolio are computed (accounting for correlations as described above).		Once risk tolerance has been established, the certain equivalent for any risky project or project portfolio can be obtained via the utility function. The effect, as illustrated in Figure 44, is to subtract a risk adjustment factor from the expected value (if projects allow you to avoid risks, the effect is to add, rather than subtract, adjustment factors). The risk adjustment depends on the risk tolerance and the amount of risk. If the projects are independent (i.e., their risks are uncorrelated), then the certain equivalent of the project portfolio will be the sum of the certain equivalents of the individual projects. If project risks are correlated, the certain equivalent for the portfolio can be obtained once the distribution of payoffs for the portfolio are computed (accounting for correlations as described above).<ref>4 http://www.prioritysystem.com/reasons5e.html</ref>

	An advantage of this approach is that a single risk tolerance can be established for the organization. Use of the common risk tolerance ensures that risks are treated consistently, thus avoiding the common bias in which greater levels of risk aversion tend to be applied by lower-level managers.		An advantage of this approach is that a single risk tolerance can be established for the organization. Use of the common risk tolerance ensures that risks are treated consistently, thus avoiding the common bias in which greater levels of risk aversion tend to be applied by lower-level managers.

Edvinas: /* Determining risk tolerance */

2017-10-02T20:56:29Z

Determining risk tolerance

← Older revision		Revision as of 20:56, 2 October 2017
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	Empirical studies have been conducted to measure organizational risk tolerances. The results show that risk tolerances obtained from different executives within the same organization vary tremendously. Generally, those lower in the organization have lower risk tolerances. Howard [9] reports that assessments from CEO's in the oil and chemicals industry concluded that risk tolerance is roughly six per cent of sales, one to one and a half times net income, or one-sixth of equity. McNamee and Celona [10] add to this list a ratio of market value to risk tolerance of one-fifth. They also comment that the ratio of risk tolerance to equity or market value [usually translates best between companies in different industries.		Empirical studies have been conducted to measure organizational risk tolerances. The results show that risk tolerances obtained from different executives within the same organization vary tremendously. Generally, those lower in the organization have lower risk tolerances. Howard [9] reports that assessments from CEO's in the oil and chemicals industry concluded that risk tolerance is roughly six per cent of sales, one to one and a half times net income, or one-sixth of equity. McNamee and Celona [10] add to this list a ratio of market value to risk tolerance of one-fifth. They also comment that the ratio of risk tolerance to equity or market value [usually translates best between companies in different industries.
	Once risk tolerance has been established, the certain equivalent for any risky project or project portfolio can be obtained via the utility function. The effect, as illustrated in Figure 44, is to subtract a risk adjustment factor from the expected value (if projects allow you to avoid risks, the effect is to add, rather than subtract, adjustment factors). The risk adjustment depends on the risk tolerance and the amount of risk. If the projects are independent (i.e., their risks are uncorrelated), then the certain equivalent of the project portfolio will be the sum of the certain equivalents of the individual projects. If project risks are correlated, the certain equivalent for the portfolio can be obtained once the distribution of payoffs for the portfolio are computed (accounting for correlations as described above).		Once risk tolerance has been established, the certain equivalent for any risky project or project portfolio can be obtained via the utility function. The effect, as illustrated in Figure 44, is to subtract a risk adjustment factor from the expected value (if projects allow you to avoid risks, the effect is to add, rather than subtract, adjustment factors). The risk adjustment depends on the risk tolerance and the amount of risk. If the projects are independent (i.e., their risks are uncorrelated), then the certain equivalent of the project portfolio will be the sum of the certain equivalents of the individual projects. If project risks are correlated, the certain equivalent for the portfolio can be obtained once the distribution of payoffs for the portfolio are computed (accounting for correlations as described above).

			An advantage of this approach is that a single risk tolerance can be established for the organization. Use of the common risk tolerance ensures that risks are treated consistently, thus avoiding the common bias in which greater levels of risk aversion tend to be applied by lower-level managers.
			Note that the method presented in this paper do not guarantee that the outcome of a particular risky decision will be optimal or "good," but only that the decision will be rational in the face of uncertainty and that repeated application of these methods will maximize the decision maker's welfare over the long run.

	== Alternative ways to model and quantify of risk tolerance ==		== Alternative ways to model and quantify of risk tolerance ==

Edvinas at 20:54, 2 October 2017

2017-10-02T20:54:04Z

← Older revision		Revision as of 20:54, 2 October 2017
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	There are several ways to determine the risk tolerance for an organization. One is to ask senior decision makers (ideally, the CEO) to answer the following hypothetical question. Suppose you have an opportunity to make a risky, but potentially profitable investment. The required investment is an amount R that, for the moment, is unspecified. The investment has a 50-50 chance of success. If it succeeds, it will generate the full amount invested, including the cost of capital, plus that amount again. In other words, the return will be R if the investment is successful. If the investment fails, half the investment will be lost, so the return is minus R/2. Figure 47 illustrates the opportunity. Note that the expected value of the investment is R/4.		There are several ways to determine the risk tolerance for an organization. One is to ask senior decision makers (ideally, the CEO) to answer the following hypothetical question. Suppose you have an opportunity to make a risky, but potentially profitable investment. The required investment is an amount R that, for the moment, is unspecified. The investment has a 50-50 chance of success. If it succeeds, it will generate the full amount invested, including the cost of capital, plus that amount again. In other words, the return will be R if the investment is successful. If the investment fails, half the investment will be lost, so the return is minus R/2. Figure 47 illustrates the opportunity. Note that the expected value of the investment is R/4.

			[[File:function.PNG\|350px\|thumb\|right\|'''Figure 1:''' Risk tolerance calculation method.]]

	If R were very low, most CEOs would want to make the investment. If R were very large, for example, close to the market value of the enterprise, most CEOs would not take the investment. The risk tolerance is the amount R for which decision makers would just be indifferent between making and not making the investment. In other words, the risk tolerance is the value of R for which the certain equivalent of the investment is zero.		If R were very low, most CEOs would want to make the investment. If R were very large, for example, close to the market value of the enterprise, most CEOs would not take the investment. The risk tolerance is the amount R for which decision makers would just be indifferent between making and not making the investment. In other words, the risk tolerance is the value of R for which the certain equivalent of the investment is zero.

Edvinas: /* Determining risk tolerance */

2017-10-02T20:52:53Z

Determining risk tolerance

← Older revision		Revision as of 20:52, 2 October 2017
Line 38:		Line 38:

	There are several ways to determine the risk tolerance for an organization. One is to ask senior decision makers (ideally, the CEO) to answer the following hypothetical question. Suppose you have an opportunity to make a risky, but potentially profitable investment. The required investment is an amount R that, for the moment, is unspecified. The investment has a 50-50 chance of success. If it succeeds, it will generate the full amount invested, including the cost of capital, plus that amount again. In other words, the return will be R if the investment is successful. If the investment fails, half the investment will be lost, so the return is minus R/2. Figure 47 illustrates the opportunity. Note that the expected value of the investment is R/4.		There are several ways to determine the risk tolerance for an organization. One is to ask senior decision makers (ideally, the CEO) to answer the following hypothetical question. Suppose you have an opportunity to make a risky, but potentially profitable investment. The required investment is an amount R that, for the moment, is unspecified. The investment has a 50-50 chance of success. If it succeeds, it will generate the full amount invested, including the cost of capital, plus that amount again. In other words, the return will be R if the investment is successful. If the investment fails, half the investment will be lost, so the return is minus R/2. Figure 47 illustrates the opportunity. Note that the expected value of the investment is R/4.



			If R were very low, most CEOs would want to make the investment. If R were very large, for example, close to the market value of the enterprise, most CEOs would not take the investment. The risk tolerance is the amount R for which decision makers would just be indifferent between making and not making the investment. In other words, the risk tolerance is the value of R for which the certain equivalent of the investment is zero.
			Empirical studies have been conducted to measure organizational risk tolerances. The results show that risk tolerances obtained from different executives within the same organization vary tremendously. Generally, those lower in the organization have lower risk tolerances. Howard [9] reports that assessments from CEO's in the oil and chemicals industry concluded that risk tolerance is roughly six per cent of sales, one to one and a half times net income, or one-sixth of equity. McNamee and Celona [10] add to this list a ratio of market value to risk tolerance of one-fifth. They also comment that the ratio of risk tolerance to equity or market value [usually translates best between companies in different industries.
			Once risk tolerance has been established, the certain equivalent for any risky project or project portfolio can be obtained via the utility function. The effect, as illustrated in Figure 44, is to subtract a risk adjustment factor from the expected value (if projects allow you to avoid risks, the effect is to add, rather than subtract, adjustment factors). The risk adjustment depends on the risk tolerance and the amount of risk. If the projects are independent (i.e., their risks are uncorrelated), then the certain equivalent of the project portfolio will be the sum of the certain equivalents of the individual projects. If project risks are correlated, the certain equivalent for the portfolio can be obtained once the distribution of payoffs for the portfolio are computed (accounting for correlations as described above).

	== Alternative ways to model and quantify of risk tolerance ==		== Alternative ways to model and quantify of risk tolerance ==