Risk Analysis in Economics: An Application to University Finances

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Discussion Paper

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Although the theory of decision making under uncertainty has been extensively studied for a half century, applications to business applications are relatively rare. This study frames a systematic risk analysis and applies the technique to the finances of private colleges and universities. It begins by constructing budgets for colleges and universities and then analyzes the major economic factors affecting those budgets. It estimates the variability (or unpredictability) associated with each major external variable from historical data and from economic forecasts. The study finds that government-spending risks outweigh all other external stock market, interest rates, inflation, and wage trends. The paper concludes by suggesting that institutions consider the implications of exogenous uncertainties other than financial markets on their economic health. It considers the development of general “spending rules” (which would be extensions of conventional “endowment spending rules”) to take into account all exogenous uncertainties.

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