Center for Advanced Management




Prof. Kalyan Raman (Northwestern University)


  • Datum: 26.06.2012
    Zeit: 18:00 - 19:30
    Ort: Kaulbachstr. 45, Raum E004


Risk as a Source of Profitability

The title of this paper may sound paradoxical since risk is typically regarded as a nuisance that impedes the profit maximization objective.  Yet, on careful theoretical examination, it becomes clear that profit could not arise without risk, for in a perfectly predictable world, neo-classical economic theory proves that competition will wipe out all profits, producing the notorious zero-profit equilibrium.  Given this tight relationship between risk and profit, it should not seem so surprising that risk is a source of profitability.  However, risk does not, spontaneously and without the decision-maker’s intervention, inevitably generate profits.  Indeed, ignoring risk in an uncertain world will almost certainly erode profitability.  We have to systematically incorporate risk into our decision making in order to turn risk into a source of enhanced profitability.  A systematic approach called stochastic optimal control was developed by Richard Bellman to optimize dynamic decision making under uncertainty.  We show that market response uncertainty can be judiciously harnessed in determining the optimal advertising budget and spending pattern to improve the expected profitability of a firm.  Using stochastic dynamic programming, we derive the optimal feedback advertising policy to accomplish this objective, and establish that the optimal advertising policy increases profitability at a rate directly proportional to the error variance.