Applying Utility Theory to Risk Management

Abstract

This paper analyzes the shortcomings of applying expected monetary value (EMV) as a tool for assessing risks and response options. It presents a more relevant set of measures based on the subjective view of stakeholders (the “utility function”) and uses these to explain apparently illogical behaviors. The analysis includes the theory of “regret” and extends this concept to include positive (“rejoice”) outcomes as well as after-the-event reviews, for which a “resentment” value is described. The challenge of managing project risk in line with stakeholder expectations requires balancing these three variables.