In managerial economics, risk refers to a situation where there are different outcomes and the probabilities of these outcomes cannot be measured with complete certainty. Risk incorporates the measurement of probability. When engaging in investment projects, there are three different types of risks. The first is stand-alone risk, which is the risk of a project in isolation and can be seen as the first level of risk analysis¹. Within-firm risk is the risk of a project in terms of a firm’s portfolio of investment projects¹. The project’s impact on the variability of the firm’s total cash flow is assessed. Market risk (or systematic risk) is the risk of a project from a shareholder’s perspective and pertains to factors that impact the entire market¹.
In risk analysis, there are three ways to measure probability. The first is theoretical where there is no need for observation because the variables are estimated from a theoretical point of view. Another way to measure probability is the empirical approach which is estimation from a historical perspective¹. Subjective probability estimation is another measure that is done when dealing with new occurrences¹.
Risk analysis is heavily employed in the financial sector. Individuals who want to make an investment need to look at the potential negative outcomes that may occur. Governments will use risk analysis for projects or activities that would create large changes in specific sectors, such as agreeing to new trade partners or building new highways. Risk analysis is used to verify the opportunity cost of a project or activity and then determine the immediate impacts, as well as the economic indicators that may appear over time.