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Risk: expected value and chance of success (view source)
Revision as of 18:30, 15 January 2014
, 18:30, 15 January 2014→Expected value concept: adding tables
Imagine that you have the opportunity to participate in a simple game in which you are asked to correctly call the toss of a fair coin. If your call is correct, you will win $20,000; if it is incorrect, you will win nothing.
Imagine that you have the opportunity to participate in a simple game in which you are asked to correctly call the toss of a fair coin. If your call is correct, you will win $20,000; if it is incorrect, you will win nothing.
{| class = "wikitable"
|-
|+ {{table number|1}}Expected value examples (Coin Toss)
|-
! Trial
! Outcome
|-
| Free trial
| Correct call
| +[[cost::20,000 USD]] – 0 =
| +[[cost::20,000 USD]] × 0.5 =
| +[[cost::10,000 USD]]
|-
|
| Incorrect call
| 0–0 =
| 0 × 0.5 =
| 0
|-
|
|
|
|
| EV =+[[cost::10,000 USD]]
|-
| [[cost::10,000 USD]] trial
| Correct call
| +[[cost::20,000 USD]]–[[cost::10,000 USD]] =
| +[[cost::10,000 USD]] × 0.5 =
| +[[cost::5,000 USD]]
|-
|
| Incorrect call
| 0–[[cost::10,000 USD]] =
| –[[cost::10,000 USD]] × 0.5 =
| –[[cost::5,000 USD]]
|-
|
|
|
|
| EV= 0
|-
| [[cost::8,000 USD]] trial
| Correct call
| +[[cost::20,000 USD]] – [[cost::8,000 USD]] =
| +[[cost::12,000 USD]] × 0.5 =
| +[[cost::6,000 USD]]
|-
|
| Incorrect call
| 0 – [[cost::8,000 USD]] =
| –[[cost::8,000 USD]] × 0.5 =
| –[[cost::4,000 USD]]
|-
|
|
|
|
| EV= +[[cost::2,000 USD]]
|}
If you were able to play such a game "for free," the expected value of each trial would be +$10,000. If you had to pay $10,000 each time you played, the EV would be zero, so that, statistically, you then would be "trading dollars." If you were willing to invest $8,000 in one trial of this game, the EV would be +$2,000 ([[Image:EVACSTb1.png|Table 1]]). In this example, there are only two possible outcomes and you are betting on one trial. It is important to emphasize that in oil and gas exploration, there are many possible outcomes. Furthermore, the concept of expected value as a decision criterion requires repeated trials. The expected value is the average profit per decision assuming repeated trials are made.
If you were able to play such a game "for free," the expected value of each trial would be +$10,000. If you had to pay $10,000 each time you played, the EV would be zero, so that, statistically, you then would be "trading dollars." If you were willing to invest $8,000 in one trial of this game, the EV would be +$2,000 ([[Image:EVACSTb1.png|Table 1]]). In this example, there are only two possible outcomes and you are betting on one trial. It is important to emphasize that in oil and gas exploration, there are many possible outcomes. Furthermore, the concept of expected value as a decision criterion requires repeated trials. The expected value is the average profit per decision assuming repeated trials are made.