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What Powerball, Poker, and SimpleRisk Have in Common

With an estimated Powerball Jackpot of $1.5B, everybody is talking about it right now.  I've got my tickets, but with a prize that big, I'm having an easier time listing the things that I can't buy with the money, rather than what I can.  That said, I keep coming back to a concept that statisticians refer to as "expected return".  What it means is that even though your odds of winning the Powerball aren't changing (roughly 1 in 292 million), the bigger the jackpot, the bigger the expected return.  To calculate it, just take the odds and multiply by the reward value.

1/292m x $1.5B = $5.14

So, before you factor in taxes, the possibility of splits, and other factors that might affect your reward, the expected return is something like $5.14 on a $2 ticket.  Not too bad.  Factoring in the cash option ($930M), a 40% Federal tax, an extra 25-28% tax from the IRS for gambling winnings, and perhaps even state taxes, however, this number drops well below the $2 range making it far less appealing to buy a ticket.  I found interesting articles in Business Insider and Wired that elaborate further on this idea.

The same concept can be applied to poker in what they refer to as "pot odds".  You take the odds of a winning hand and multiply it by the size of the pot.  In poker, often times players are more willing to play what is normally a statistically losing hand if it gives them a shot at more money (ie. a bigger pot).

So what does this have to do with SimpleRisk and risk management?  The classic formula for calculating risk is RISK = LIKELIHOOD x IMPACT and is the exact same formula used for calculating expected return and pot odds.  You're simply taking the likelihood of an event happening regardless of whether it is a positive or negative outcome and multiply it by the estimated dollar value of that outcome.  Pretty simple.  And that is what Powerball, Poker, and SimpleRisk have in common.