Risk Analysis for Engineering 12 ppt

• A. J. Clark School of Engineering •Department of Civil and Environmental Engineering CHAPTER 7a CHAPMAN HALL/CRC Risk Analysis in Engineering and Economics Risk Analysis for Engineering Department of Civil and Environmental Engineering University of Maryland, College Park RISK CONTROL METHODS CHAPTER 7a. RISK CONTROL METHODS Slide No. 1 Introduction ̈ In general, risk management is performed within an economic framework with an objective of optimizing the allocation of available resources in support of a broader goal. ̈ Therefore, it requires the definition of acceptable risk, and comparative evaluation of options and/or alternatives for decision making. CHAPTER 7a. RISK CONTROL METHODS Slide No. 2 Introduction ̈ Risk control has an objective to reduce risk to an acceptable level and/or prioritize resources based on comparative analysis. ̈ The objective of this chapter is to introduce fundamental concepts for risk control within an economic framework that include risk aversion, risk homeostasis, discounting procedures, decision analysis, tradeoff analysis, insurance models, and repair and maintainability issues. CHAPTER 7a. RISK CONTROL METHODS Slide No. 3 Philosophies of Risk Control ̈ Risk control can be approached by an organization within a strategic, or a system-wide, or an organization-wide plan. ̈ A philosophy for risk control might be constructed based on recognizing that the occurrence of a consequence-inducing event is the tip of an iceberg representing a scenario. CHAPTER 7a. RISK CONTROL METHODS Slide No. 4 Philosophies of Risk Control ̈ The domino theory for risk control was used in industrial accident prevention to eliminate injury-producing events by construction a domino sequence of events as demonstrated by the following sequence: – A personal injury as the final domino occurs only as a result of an accident. – An accident occurs only as a result of a human-related or mechanical hazard. CHAPTER 7a. RISK CONTROL METHODS Slide No. 5 Philosophies of Risk Control – A human-related or mechanical hazard exits only as a result of human errors or degradation of equipment. – Human errors or degradation are inherited or acquired as a result of their environment. – An environment is defined by conditions into which individuals or processes are placed. ̈ This philosophy might be suitable for some applications such as manufacturing, construction, production, and material handling. CHAPTER 7a. RISK CONTROL METHODS Slide No. 6 Philosophies of Risk Control ̈ A related philosophy for risk control is the cascading-failure theory for risk control according to which control strategies are identified by investigating cascading failures. ̈ For example, a loss of electric power to a facility might lead to the failures of other systems leading to the failure of additional systems, and so on. CHAPTER 7a. RISK CONTROL METHODS Slide No. 7 Philosophies of Risk Control ̈ In this case, risk control can target increasing power availability as a solution. ̈ The following strategies can be adopted within this philosophy: – The creation of the hazard can be prevented in the first place during the concept development and design stages. For example, having no-smoking rules can be adopted to reduce the risk associated with fires, and the use of pressure relief valves are used to reduce risks associated with over- pressurizing vessels and tanks. CHAPTER 7a. RISK CONTROL METHODS Slide No. 8 Philosophies of Risk Control – The damage already done by the hazard can be countered and contained. For example, fire sprinkler systems and emergency response teams can be used to protect a facility. – The object of damage can be repaired and rehabilitated. For example, injured workers, and salvage operations can be rehabilitated after an accident. CHAPTER 7a. RISK CONTROL METHODS Slide No. 9 Philosophies of Risk Control ̈ A risk control Philosophy needs also to define the control measures, time of application, and target of the risk-control measures. ̈ The control measures can include pressure relief valves, firewalls, and emergency response teams. ̈ The timing of application identify when the measure is needed, such as, prior an event, at the time of an event, or after an event occurrence. CHAPTER 7a. RISK CONTROL METHODS Slide No. 10 Philosophies of Risk Control ̈ The targets of the risk control measures could include workers, visitors, machinery, assets, or a population outside a plant. CHAPTER 7a. RISK CONTROL METHODS Slide No. 11 Risk Aversion in Investment Decisions ̈ Risk control can be examined within an economic framework by constructing cash flows for available alternatives as investments. ̈ Selecting an optimal alternative can be based on the expected or average NPV as was demonstrated in decision-tree analyses. CHAPTER 7a. RISK CONTROL METHODS Slide No. 12 Risk Aversion in Investment Decisions ̈ However, this selection criterion might not reflect the complexities involved in real decision situations. ̈ This section utilizes an example investment decision under uncertainty to introduce some key concepts and related complexities. CHAPTER 7a. RISK CONTROL METHODS Slide No. 13 Risk Aversion in Investment Decisions ̈ A decision situation involves three alternatives A, B, and C that could lead to several scenarios each. ̈ These scenarios and their respective NPV values are shown in Table 1. ̈ The table shows that alternatives A and B have generally smaller returns and smaller spreads than alternative C. CHAPTER 7a. RISK CONTROL METHODS Slide No. 14 Risk Aversion in Investment Decisions 1/282/283/284/285/286/287/28Decreasing Likelihood 7/286/285/284/283/282/281/28Increasing Likelihood 1/71/71/71/71/71/71/7Equally likely Probabilities (p) 120010008006004002000Alternative C ($) 900800700600500400300Alternative B ($) 700600500400300200100Alternative A ($) Net Present Values (NPV) Extremely High Very HighHighGoodLow Very Low Extremely LowQuantity Table 1. Scenarios for Three Alternatives CHAPTER 7a. RISK CONTROL METHODS Slide No. 15 Risk Aversion in Investment Decisions ̈ Table 2 shows the descriptive statistics of the NPV of alternatives A, B and C using the three probability distributions for the scenarios of equally likely, increasing likelihood, and decreasing likelihood (p). ̈ The descriptive statistics were computed as follows: ∑ = = = 7 1 )( value,Expected N i ii pNPVNPVE (1) CHAPTER 7a. RISK CONTROL METHODS Slide No. 16 Risk Aversion in Investment Decisions 0.8660.3460.577 Coefficient of Variation of NPV 346.41173.21173.21 Standard Deviation of NPV ($) 400500300 Expected NPV ($) Decreasing Likelihood 0.4330.2470.346 Coefficient of Variation of NPV 346.41173.21173.21 Standard Deviation of NPV ($) 800700500 Expected NPV ($) Increasing Likelihood 0.6670.3330.5 Coefficient of Variation of NPV 400200200 Standard Deviation of NPV ($) 600600400 Expected NPV ($) Equally likely Alternative CAlternative BAlternative AQuantity Table 2. Descriptive Statistics of the Net Present Values of Alternatives A and B CHAPTER 7a. RISK CONTROL METHODS Slide No. 17 Risk Aversion in Investment Decisions () ∑ = = −= 7 1 2 )()( deviation, Standard N i ii NPVENPVpNPV σ )( )( )(COV , variationoft Coefficien NPVE NPV NPV σ = (2) (3) CHAPTER 7a. RISK CONTROL METHODS Slide No. 18 Risk Aversion in Investment Decisions ̈ The inconclusive decision situation in this example can be attributed to the level of satisfaction, which an investor might reach based on each alternative. ̈ This level of satisfaction for each level of NPV (or generally called wealth W) that corresponds to each scenario is called utility (U) that represent the risk attitude of investors. CHAPTER 7a. RISK CONTROL METHODS Slide No. 19 Risk Aversion in Investment Decisions ̈ The risk attitude of an investor or decision maker may be thought of as a decision maker’s preference of taking a chance on an uncertain money payout of known probability versus accepting a sure money amount, i.e., with certainty. ̈ For example, a person having a choice between (1) accepting the outcome of a fair coin toss where heads means winning [...]... Insurance for Loss Control and Risk Transfer ̈ ̈ ̈ Risk management including loss control is of central importance for insurers Insurers typically perform rigorous studies and review before placing insurance on systems, followed by periodic site visits, and specialized studies Some insurers utilize specialized methods and protocols for performance measurement and verification CHAPTER 7a RISK CONTROL... utility grows slower than wealth represent risk- aversive investors The intensity of risk aversion depends the amount of curvature in the curve The larger the curvature for this concave curve, the higher the risk aversion Although is not as common, investors could display risk propensity, called riskseeking investors Slide No 35 CHAPTER 7a RISK CONTROL METHODS Risk Aversion in Investment Decisions ̈ In... the figure Slide No 55 CHAPTER 7a RISK CONTROL METHODS Risk Aversion in Investment Decisions Expected NPV (k$) 140 D6 Efficient Frontier 120 D1 100 D5 80 D3 D4 60 40 D2 Risk- Avoider Curves Risk- Seeker Curves 20 0 0 20 40 60 80 Standard Deviation of NPV (k$) Figure 8 Efficient Frontier and Utilities for Design Alternatives CHAPTER 7a RISK CONTROL METHODS Slide No 56 Risk Aversion in Investment Decisions... CHAPTER 7a RISK CONTROL METHODS Risk Aversion in Investment Decisions Table 7 Expected Value and Standard Deviation of Profits for Car Product Designs Alternatives Expected Profit ($1000) Standard Deviation of Profit ($1000) A 50 30 B 50 225 C 300 120 D 550 120 E 800 225 CHAPTER 7a RISK CONTROL METHODS Slide No 60 Risk Aversion in Investment Decisions ̈ Example 4 (cont’d): – To model the risk attitude... attitude is called risk aversion Slide No 30 CHAPTER 7a RISK CONTROL METHODS Risk Aversion in Investment Decisions ̈ In general, risk aversion can be defined by the following relationship: U E ( NPV ) (6a) E U ( NPV ) or U E (W ) ̈ (6b) E U (W ) The utility function used in the previous example is for a risk- averse investor as shown in Figure 1 Slide No 31 CHAPTER 7a RISK CONTROL METHODS Risk Aversion... )) Slide No 36 CHAPTER 7a RISK CONTROL METHODS Risk Aversion in Investment Decisions 9000 8000 Utility (NPV) 7000 Scenario probability = 0.5 6000 (1000,500) 5000 4000 3000 Scenario probability = 0.5 2000 (200,148) 1000 0 0 200 400 600 800 1000 120 0 Net Present Value (NPV), $ Figure 2 Utility Function for a Risk- Seeking Investor Slide No 37 CHAPTER 7a RISK CONTROL METHODS Risk Aversion in Investment... resources A risk neutral investor has a utility function without curvature as shown in Figure 3 In this case the utility function is linear, and meets the following condition: U E ( NPV ) or U ( E (W ) E U ( NPV ) (12a) E U (W ) (12b) CHAPTER 7a RISK CONTROL METHODS Slide No 40 Utility (NPV) Risk Aversion in Investment Decisions Net Present Value (NPV), $ Figure 3 Utility Function for a Risk- Neutral... 66 Risk Homeostasis ̈ ̈ ̈ Risk homeostasis could have a great implication on selecting risk mitigation actions Traditional risk mitigation practices can therefore be called into question, such as prohibiting drinking and driving, or closing the borders to the illicit drug trade Risk mitigation actions that are dependent on human conduct might not work or might not be effective in general CHAPTER 7a RISK. .. No 67 Risk Homeostasis ̈ ̈ These conclusions emphasize the need to account for human behavior within risk mitigation actions, and devoting efforts to changing the behavior of humans, aimed at increasing people's desire to be safe and to live a healthy lifestyle Thus, in addition to enforcement, educational, and engineering approaches, a motivational approach to prevention is needed CHAPTER 7a RISK. .. Deviation of NPV (k$) Figure 7 Efficient Frontier for Design Alternatives 80 Slide No 54 CHAPTER 7a RISK CONTROL METHODS Risk Aversion in Investment Decisions ̈ Example 3: Selecting Optimal Design Alternative Based on Different Risk Attitudes – Figure 8 shows two cases of a risk- averse management of the company and risk seeking management – If the management is risk averse, the utility curves subjectively . J. Clark School of Engineering •Department of Civil and Environmental Engineering CHAPTER 7a CHAPMAN HALL/CRC Risk Analysis in Engineering and Economics Risk Analysis for Engineering Department. fundamental concepts for risk control within an economic framework that include risk aversion, risk homeostasis, discounting procedures, decision analysis, tradeoff analysis, insurance models,. Environmental Engineering University of Maryland, College Park RISK CONTROL METHODS CHAPTER 7a. RISK CONTROL METHODS Slide No. 1 Introduction ̈ In general, risk management is performed within