Risk Management Technique

Risk Measurement Technique Paper

Risk management deals with identifying and assessing uncertainty on objectives. Once risks have been identified, they need to be measured. Most risk measurement techniques are a form of quantitative analysis. Quantitative techniques are used most commonly when time and a budget are a main factor in a corporation’s decision. Merna and AL-Thani (2008) say “quantitative techniques attempt to determine absolute value ranges together with probability distributions for the business or project outcome.” Three types of quantitative risk measurement techniques are decision trees, Monte Carlo simulation and sensitivity analysis.

Decision Trees are diagrams that display different decisions and chance events for a project. Most businesses strive to pick the best choice that will benefit them when faced with decisions. Decisions trees are helpful in this sense by laying out a physical diagram with each possible decision along with the probability for each one and their weighted values, which calculate to their expected outcome. Some “branches” could have multiple decisions that need to be made which are depicted in sequential decisions making order and each will display their expected outcome. The best decision for a business would be one that fit within their budget and with the highest expected outcome. (***) The advantage to using decision trees are that they are clean and simply laid out and easy to interpret. They are also useful in labeling and indicating the best and worst possible decisions.

Monte Carlo simulations use random numbers to simulate consequences for uncertain events. It’s used as a way to determine how a situation would change/react given different inputs. To use Monte Carlo simulations you first need to assign a probability distribution to any variable that would affect the projects internal rate of return or net present value, then determine an appropriate range of variation each individual variable could experience....