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Risky choices and correlated background risk

Publication ,  Journal Article
Tsetlin, I; Winkler, RL
Published in: Management Science
September 1, 2005

The analysis of a risky project should take into account not only uncertainties about the return from, that project ("project risk"), but also uncertainties associated with other ongoing projects and with exogenous factors that can impact final wealth ("background risk"). The presence of background risk can change the optimal course of action with respect to a project, and ignoring such risk might lead to a poor decision. Most work on background risk assumes that project risk and background risk are independent and are additive in their impact on wealth. However, independence is often unrealistic, and background risk operates in a multiplicative manner in many situations. We relax the independence assumption and consider a model with both additive and multiplicative background risk. The optimal decisions in the correlated setting can be very different than those that would appear optimal if the correlation were ignored. The impact of correlation differs in the additive and multiplicative cases, with positive correlation being beneficial in some cases and negative correlation in others. The analytical and numerical results indicate that in analyzing decision-making problems, it is very important to understand the direction and degree of dependence between project risk and background risks. © 2005 INFORMS.

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Published In

Management Science

DOI

EISSN

1526-5501

ISSN

0025-1909

Publication Date

September 1, 2005

Volume

51

Issue

9

Start / End Page

1336 / 1345

Related Subject Headings

  • Operations Research
  • 46 Information and computing sciences
  • 38 Economics
  • 35 Commerce, management, tourism and services
  • 15 Commerce, Management, Tourism and Services
  • 08 Information and Computing Sciences
 

Citation

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Tsetlin, I., & Winkler, R. L. (2005). Risky choices and correlated background risk. Management Science, 51(9), 1336–1345. https://doi.org/10.1287/mnsc.1050.0414
Tsetlin, I., and R. L. Winkler. “Risky choices and correlated background risk.” Management Science 51, no. 9 (September 1, 2005): 1336–45. https://doi.org/10.1287/mnsc.1050.0414.
Tsetlin I, Winkler RL. Risky choices and correlated background risk. Management Science. 2005 Sep 1;51(9):1336–45.
Tsetlin, I., and R. L. Winkler. “Risky choices and correlated background risk.” Management Science, vol. 51, no. 9, Sept. 2005, pp. 1336–45. Scopus, doi:10.1287/mnsc.1050.0414.
Tsetlin I, Winkler RL. Risky choices and correlated background risk. Management Science. 2005 Sep 1;51(9):1336–1345.

Published In

Management Science

DOI

EISSN

1526-5501

ISSN

0025-1909

Publication Date

September 1, 2005

Volume

51

Issue

9

Start / End Page

1336 / 1345

Related Subject Headings

  • Operations Research
  • 46 Information and computing sciences
  • 38 Economics
  • 35 Commerce, management, tourism and services
  • 15 Commerce, Management, Tourism and Services
  • 08 Information and Computing Sciences