EMBA的小眼睛

Are you feeling lucky?

Expected value is a powerful concept, easy to understand, often difficult to use in daily life.

It's the value of an outcome multiplied by the chances it will happen.

If there's a one in ten chance you'll get a $50 ticket for parking here, the expected value (the cost) of parking here is $5. Park here enough times, and that's what it's going to cost you.

If there's a one in five chance you'll win that lawsuit for a million dollars, the expected value of the suit is $200,000.

That's not a guess or a vague hunch, it's actually true. If the odds are described properly (and setting those odds is an entirely different discussion) then the value of the opportunity (or the cost of it) is clear.

And yet...

And yet we anchor our risks, often overestimating just how much it's going to cost us to get a ticket.

And we anchor our possible gains, usually overestimating how much that opportunity is worth (which is why so few lawsuits that should settle, do).

Humans are quite bad at dealing with ambiguity, and even worse when there's money on the table. Ellsberg's paradox helps us understand some of the bugs in the system, and perhaps we can take better risks by using a pencil, not our gut, to decide what a chance is worth.