How to Estimate your Tolerance for Risk

James A. MacKay

Risk tolerance is used to calculate the Risk Adjusted Value (RAV) of a proposed investment. The RAV incorporates both the expected value and risk attitude for a particular investment, taking into consideration your concern for catastrophic financial loss, as well as chance of success, cost and value if successful. Uncertainty can be incorporated into all of the above variables. Often a project is more valuable to a corporation if a partial working interest is taken rather than the entire working interest. The RAV can be used to calculate the optimum working interest and the value of that diversification.

To estimate the Apparent Risk Tolerance (ART) of an individual, division or corporation several methods can be employed:

-- ART can be calculated from the working interest selected in prior investment decisions;

-- ART can be estimated from a selection of working interests by the decision maker in a proposed portfolio of projects;

-- ART can be approximated from data released to the Security and Exchange Commission (SEC) in the annual 10K supplements (for both your company and possible partners); and

-- ART can be assigned based on corporate size, budget, or activity.

Examples are provided for the various methods to identify risk tolerance and apply it in making optimum working interest calculations for individual projects and portfolios.

AAPG Search and Discover Article #91019©1996 AAPG Convention and Exhibition 19-22 May 1996, San Diego, California