Question

An individual owns a $100,000 home. She determines that her chances of suffering a fire in any given year to be 1/1000 (0.001). She correctly calculates the expected loss in any year to be $100. Explain why this really isn't a good way to measure her potential for loss.

Answer 1

This is not a best way to calculate her potential for loss since the individual would be better off examining the value at risk which would be the worst outcome.

Step-by-step explanation:

Solution

Recall that:

An individual owns a home wit the amount of $100,000

The expected loss in any year = $100

Chances of suffering a fire in any given year be 1/1000 (0.001).

Now

This is not a best approach or method to estimate her potential for loss because the individual would be better off considering the value at risk which would be the worst outcome.

The value at risk, in this case, is equal to 100000 which would be the worst outcome.