Risk Analysis

This is first of a multi-part series to examine how we react to weather (and other) threats.  More generally, it is how we make decisions in all aspects of our life. Surrounding events such as the decision to evacuate in view of an approaching hurricane, or even in preparations for a possible hurricane, a number of decisions are made. These mirror the multitude of decision we all make every day.  There are many treatises on the theory of decisions making, risk analysis and cost benefit analysis.  Indeed they would fill many library shelves. But we are going to apply Occam’s razor or the colloquial KISS system, and consider only the basics. 

 Decisions can be rational, or irrational, the distinction being that rational decisions follow a logical analysis, consciously or subconsciously. We will consider only rational decisions and acts, as irrational ones defy analysis of the type we consider here.  However, we all make both types.  For me, the irrational decision are either very good or very bad, often the later.  Love is often irrational, unless you are Donald Sterling’s wife or girl friend.

 Secondly, decisions can be either binary, or where the course of action is the optimal choice, and is not an either/or choice.  Personally, I really like optimization problems.  In every case, the choices made require the decisions to me made by using the same units. In business it is usually cost, or dollars.  In many other situations, it is very difficult because the cost and benefit may be in different units, such as human life, dollars, time, belief system, etc.

 In the final analysis, a decision that relates dollars and human life, for example, can actually end up putting a dollar value on human life.  And that can be almost anything. Very often these decisions are incredibly agonizing to make.  Yet, we make them, and even in refusing to make them we in fact do make them.  There is no escape.

 All decisions go through a process we can call an algorithm, whether it is to optimize a variable (such as profit) or to make a binary decision (such as to bring an umbrella).  It may be a conscious decision (such as making a list of pros and cons) or it may be less reasoned, such as when and where to cross a street.  The collection of choices and decisions we make, go a long way to defining who we really are. 

 As we will see in the next installment, the decisions we make in the approach of a hurricane are VERY dependent on the accuracy of the forecast.  But first, let us consider the process that we might use to make a thoughtful and thought-out decision in the preparation and response to an event such as a hurricane.

We have an input, an algorithm, and an output, which is the decision. The algorithm, as we have called it, is the process we use to make the conscious decisions. There are many definitions of the word “RISK” and the etymology is fascinating and shows the migration of meaning, as often happens with words.  But I want to propose a particular definition that I think fits many applications today.  This is because “Risk”, and our assessment of it in a “cost benefit analysis”, governs our behavior, even our every day decisions and actions.    Central to this quasi-analytical approach is the fact that even if we can quantify risk, each of us will have a different approach to it, and different responses to it.

 Often the probably of a good out come is 1 minus the probability of a bad outcome.   In this formulation, zero risk is break even, and negative values portend, on the average, a gain.  It all depends on the probability and the potential costs or gain. The problem with this is that the although the risk can be extremely high if the probability of winning is low and the cost is high, but the probability of a “profit” (negative values)  is limited to a value of one.

 A bet on head or tails would be at zero risk in the long run since the probability of heads or tails is the same, and if the payoff of winning is the same as the cost of loosing, it is a toss up.  However if it the winning side payoff is 2 dollars and loosing costs only 1 dollar, then the risk is a - .5., or little risk at and, in fact, a winning strategy.

 “Opportunity” could be defined the same way, by flipping the fraction.

 Cost - Benefit analysis, or Benefit – Cost analysis, is simply weighing the benefit to the cost. In a binary decision it is (employing the same unit of measure) the benefits of an action vs the cost of the action. We do this all the time, many times a day.  This can also be applied to an optimization problem.  It can be expressed as a fraction, or as the difference.

 We make list of “pros” and “cons” to help us make some decisions.  More that the length of the columns, it is the process of developing that list that helps clarify the decision.

 

We will go into the application of these methodologies and how we either consciously or subconsciously employ them in both big and small decisions every day.  Also how does this relate to our decisions surrounding hurricanes or other weather hazards.