Risk-reward model

If the preceding chapter is correct, economics is at risk of meeting a similar fate. Its well-crafted models of rational choice in a world of free, enforceable contracts have become unproductive, and continued growth depends on the flexibihty to strike out in new directions. Fortunately, the theoretical environments that can prove hospitable to migrating economists already exist, and the journey is not too far. This chapter will discuss alternative approaches to the analysis of risk, the structure of labor markets, and the nature of the employment relationship. In the end, I will try to show that, together, they can largely explain the broad historical and institutional facts of risk, reward, and conflict. 

These are but a few of them single event theory chain of events theory epidemiological models systems theory models multilinear events sequencing human factors models life change unit theory motivation-reward satisfaction models and the management oversight and risk tree model. 

As we show in this paper, the main reason for this weakness is that the expected utihty theory theory does not consider the impact of the actual number of risk-reward bets in a risky prospect. The choice under risk is made as if each compared risky prospect contains a very large number of risk-reward bets. This critical dependence has been missed in smdies related to ranking risky alternatives (Tobin, 1958 Hansch and Leuy, 1969 Hador and Russel, 1969). It has also been missed in more recent models related to ranking risky alternatives (Richardson and Outlaw, 2008) and decision making without expected utihty (Nielsen and Jaffray, 2006 Starmer, 2000). 

A firm s investment in protection reflects risk/reward tradeoff that is based on the cost of protecting an asset, the potential loss if the asset is damaged, and the vulnerability of the asset. While the firm must assess the cost of protection and potential loss, the goverimient can help with information on vulnerability and risk assessment. For example, companies look to the National Hurricane Center (NHS) as a source of information on natural hazard indications, warnings, and threat assessments. The firm can then figure out how much to invest in protecting certain assets. Models can help in quantifying the benefits in terms of reduction in lost lives, social disruption, and financial loss (Chakravarty 2011). A cost-benefit analysis of different options can identify the best set of options. 

An example from another arena often helps people in the pharmaceutical industry understand the concepts around dynamic modeling and risk assessment incorporating uncertainty. The petroleum industry has used these approaches for years to help evaluate the risks and rewards associated with a portfolio of investment opportunities. At a 10,000 ft view, the structure inherent in the petroleum industry can be depicted as shown in Figure 35.11. 

The business model of the innovative pharmaceutical industry is to transform the results of basic medical research into products that provide health benefits to the patient. This model is characterized by a high risk of failure in the development of new products, coupled with the benefit of market exclusivity for a number of years if a product can be successfully developed and is approved by the regulatory agencies. Only very few chemical entities complete the development process from drug discovery to a commercial product. But those products that do reach the marketplace have to yield sufficient financial rewards to assure that the... 

Bosma, H., Peter, R., Siegrist, J., Marmot, M. (1998). Alternative job stress models and risk of coronary heart disease. The effort-reward imbalance model and the job strain model. AmencanJoKwa/o/Pn /jc/fea/// , 88, 68-74. 

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