Summary 573- Recall the earlier example of assessing the risk of loan defaults. Suppose
the bank’s top managers are divided on whether to adopt the scoring
system permanently. A number of top officers believe their intuitive
judgment about risks is superior to an “artificial” score. Accordingly, the
bank decides to test its judgment against the scoring system. The
managers will make their own designations of loans to the four
categories and see how well they can identify problem loans. Their track
record over the past year is shown in the table:
Category Performing Loan Defaulted Loan
A (“zero” risk) .25 .20
B (solid) .30 .25
C (uncertain) .40 .45
D (high risk) .05 .10
Total 1.00 1.00a. Predict the probability of default for each loan category. (Assume the
overall default rate is 10 percent: Pr(default) .1.)
b. How do these risk assessments, based on judgment and intuition,
compare with the earlier predictions based on credit scores? Which
seems to provide more valuable information? Explain.- Firm B is considering whether to pursue an R&D effort to develop a
powerful new microchip. One concern with the design is that the chip
might generate too much heat operating at high speeds. Indeed, there
is the risk that the heat problem will doom the R&D effort. Firm B’s
scientists believe that there is a .5 chance that the R&D effort will
succeed (S) and a .5 chance it will fail (F). If the effort succeeds, there
is a second risk. Firm B has filed several patents concerning the design
of the chip. If these patents are upheld in court, it will have the
exclusive right to produce the chip. However, a competitor, firm Z, has
been pursuing a similar chip design and has filed its own patents. If the
courts decide in favor of firm Z, both firms will be free to produce
similar chips and will share the market. Firm B’s legal department
estimates a .6 chance that its patents will be upheld giving it exclusive
production rights.
The following table lists firm B’s possible profit outcomes.
Failed R&D investment $40 million
Successful R&D/Exclusive production rights $50 million
Successful R&D/Shared production rights $5 millionc13TheValueofInformation.qxd 9/26/11 11:02 AM Page 573