0 INTRODUCTION

Chapter 1 Decision Theory

0 Introduction

First let us look at some games. In these games, players will need to make decisions about the strategies they adopt. Children deciding how to divide up a bag of mixed sweets fairly A manager deciding how to allocate the bonus pool to his sta The behavior of a predator and its prey The UN setting pollution limits for dierent countries Criminals deciding whether to grass up their accomplices

0 INTRODUCTION

In this chapter we will look at some methods that can be used to help determine appropriate strategies in various situations. We will look at GAME THEORY and STATISTICAL GAMES as in introduction to DECISION THEORY. zero-sum two-player games domination / minimax criterion / randomized strategies statistical games decision criteria minimax criterion / Bayes criterion

1 ZERO-SUM TWO-PLAYER GAMES

Zero-sum two-player games

A game is said to be zero-sum when there are players in conict and whatever one player loses in a game another player wins. MORE than two players / NOT zero-sum / It is assumed in game theory that in choosing their own strategy neither player knows what the other player will do and once a strategy has been chosen it cannot be changed. The game can be represented by a matrix. Player A and Player B Options Payos Game theory seeks to establish optimum strategies: Most protable to each player Value of the game: expected payo when the players use their optimum strategies.

1 ZERO-SUM TWO-PLAYER GAMES

1.1

Domination

There are several tools that we can use to helps us nd a players optimum strategy. The rst of these is to discard any dominated strategies. In a payo matrix one strategy is said to dominate another strategy if the choice of the rst strategy is at least as good as the choice of the second strategy and in some cases better. A dominated strategy can always be discarded in a game.

1 ZERO-SUM TWO-PLAYER GAMES

1.2

The Minimax Criterion

If we cannot determine the optimum strategy for each player on the basis of domination alone, we could use some other tools, e.g. the minimax criterion. The minimax criterion: each player chooses the strategy that minimizes their maximum loss or equivalently, maximizes their minimum gain. A SADDLE POINT: A pair of strategies will be in equilibrium if and only if the element L(a, b) corresponding to the equilibrium is both the largest in its column and the smallest in its row. Such equilibrium is called a saddle point. NOT all matrices have saddle points. If a game DOES NOT have a saddle point, then the minimax strategies are NOT spy-proof. In cases such as this, each player should adopt a randomized strategy.

1 ZERO-SUM TWO-PLAYER GAMES

1.3

Randomized Strategies

Given that a player does not know how his opponent will behave, and that his optimum strategy is a function of his opponents, how should a player behave in order to reduce his excepted maximum loss to a minimum? One way to do this is to introduce a randomized strategy, that is to adopt a strategy in which the courses of action are chosen in some random way. How do we choose the probabilities involved to make the excepted maximum loss as small as possible?

2 STATISTICAL GAMES

Statistical games

In statistical inference, decisions about populations are based on sample data. Therefore statistical inference can be regarded as a game between NATURE and the statistician. In a statistical game the statistician has some sample data, which will give some information about Natures choice. See an Example on pages 14-18. Another Example on pages 19-20.

3 DECISION CRITERIA

Decision criteria

In general it is possible to nd the best decision function only in respect of some CRITERIA. Two criteria are considered: The minimax criterion The Bayes criterion

3 DECISION CRITERIA

3.1

The minimax criterion

Under the minimax criterion the decision function d chosen is that for which R(d, ), maximized with respect to , is a minimum.

3 DECISION CRITERIA

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3.2

The Bayes criterion

If is regarded as a random variable under the Bayes criterion the decision function chosen is that for which E[R(d, )] is a minimum where the expectation is taken with respect to . The criterion needs to be regarded as a random variable with a given distribution.