Part 2. MM4XL Tools > 1. Strategic Tools > Decision Tree > 4. Anatomy of a Decision Tree Output Report > Technicalities > Utility Functions > Certainty Equivalent

Decision Tree

Certainty Equivalent

The certainty equivalent (CE) is that amount of money one would accept to avoid the risk of the venture. If we had to choose one of two options, say, enter the business or save X dollars by not entering it, what is the value of X, the CE of the risky venture, that would make us indifferent between the two options? In this sense, CEs help determine the value of projects as risk increases. DTree takes care of all tedious aspects of the computation and switches easily between values.

Subtracting CE from EMV returns the risk premium, which is the price one is willing to pay in order to avoid risk. This could be useful to the marketing manager opting for running a marketing research study, as long as the cost of the study does not exceed the risk premium.

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