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DecisionAnalysis DRSZ
DecisionAnalysis DRSZ
1
6.1
2 Introduction to Decision Analysis
Payoff Tables
DJA is up more DJA is up DJA moves DJA is down DJA is down more
than1000 points [+300,+1000] within [-300, -800] than 800 points
[-300,+300]
A pessimistic decision maker believes that the worst possible result will always occur.
A conservative decision maker wishes to ensure a guaranteed minimum possible payoff.
TOM
15
BROWN - The Maximin Criterion
=MAX(H4:H7)
=MIN(B4:F4)
Drag to H7
* FALSE is the range lookup argument in
the VLOOKUP function in cell B11 since the =VLOOKUP(MAX(H4:H7),H4:I7,2,FALSE
values in column H are not in ascending )
order
17 The Maximin Criterion -
spreadsheet
I4
Cell I4 (hidden)=A4
Drag to I7
Calculate the regret for each decision alternative as the difference between its payoff value
and this best payoff value.
For each decision find the maximum regret over all states of nature.
Select the decision alternative that has the minimum of these “maximum regrets.”
21 TOM BROWN – Regret Table
The
ThePayoff
PayoffTable
Table
Decision
Decision Large
Largerise
rise Small
Smallrise
rise No
Nochange
changeSmall
Smallfall
fall Large
Largefall
fall
Gold
Gold -100
-100 100
100
Investing in200
200 300
300 no 00
Stock generates
Bond
Bond 250
250 200
200 when150
regret 150 -100
the market exhibits -150
-100 -150
Stock
Stock 500
500 250
250 a100large rise-200
100 -200 -600
-600
C/D
C/D 60
60 60
60 60
60 60
60 60
60
The
TheRegret
RegretTable
Table
Decision
Decision Large
Largerise
riseSmall
Smallrise
riseNo
Nochange
changeSmall
Smallfall
fall Large
Largefall
fall
Gold
Gold 600
600 150
150 00 00 60
60
Bond 250 Let us
50 build the
50 Regret Table
400 210
Bond 250 50 50 400 210
Stock
Stock 00 00 100
100 500
500 660
660
C/D
C/D 440
440 190
190 140
140 240
240 00
22 TOM BROWN – Regret Table
The
ThePayoff
PayoffTable
Table
Decision
Decision Large
Largerise
rise Small
Smallrise
rise No
Nochange
changeSmall
Smallfall
fall Large
Largefall
fall
Gold
Gold -100
-100 100
Investing 200
100 in200 300
300 a regret
gold generates 00
Bond
Bond 250
250 200
200 150
of 600 when -100
150 the market -150
-100 exhibits-150
Stock
Stock 500
500 250
250 100
100
a large -200
Th rise
-200 -600
-600
C/D 60 60 60 e op 60 60
C/D 60 60 60 60
tim 60
500 – (-100) = 600 al
de
The
The Regret
Regret Table
Table
cis
Maximum
Maximum
ion
Decision
Decision Large
Large rise
rise Small
Smallrise
riseNo
No change
change Small
Smallfall
fall Large
Large fall
fall Regret
Regret
Gold
Gold 600
600 150
150 00 00 60
60 600
600
Bond
Bond 250
250 50
50 50
50 400
400 210
210 400
400
Stock
Stock 00 00 100
100 500
500 660
660 660
660
C/D
C/D 440
440 190
190 140
140 240
240 00 440
440
23 The Minimax Regret - spreadsheet
=MAX(B14:F14)
Drag to H18
=MAX(B$4:B$7)-B4
Drag to F16
=MIN(H13:H16)
=VLOOKUP(MIN(H13:H16),H13:I16,2,FALSE)
24 Decision Making Under Uncertainty -
The Maximax Criterion
This criterion is based on the best possible scenario.
It fits both an optimistic and an aggressive decision maker.
Th
eo
pti
al m
The Maximax Criterion Maximum
de
Decision Large rise Small rise No change Small fall Largecisfall Payoff
Gold -100 100 200 300 0 ion 300
Bond 250 200 150 -100 -150 200
Stock 500 250 100 -200 -600 500
C/D 60 60 60 60 60 60
Decision Making Under Uncertainty - The
27
RESULTS
Criteria Decision Payoff
Maximin C/D Account 60
Minimax Regret Bond 400
Maximax Stock 500
Insufficient Reason Gold 100
EV Bond 130
EVPI 141
30 Decision Making Under Risk
The
opt
im a
The Expected Value Criterion l deci Expected
sion
Decision Large rise Small rise No change Small fall Large fall Value
Gold -100 100 200 300 0 100
Bond 250 200 150 -100 -150 130
Stock 500 250 100 -200 -600 125
C/D 60 60 60 60 60 60
Prior Prob. 0.2 0.3 0.3 0.1 0.1
=SUMPRODUCT(B4:F4,$B$8:$F$8)
Drag to G7
=MAX(G4:G7)
=VLOOKUP(MAX(G4:G7),G4:H7,2,FALSE)
6.435 Expected Value of Perfect Information
The gain in expected return obtained from knowing with certainty the future state of
nature is called:
The-100
Expected Value of Perfect Information
Decision Large
Largerise
rise Small rise No change Small fall Large fall
Gold 250
-100 100 200 300 0
Bond 250 200 150 -100 -150
Stock
Stock 500500 250 100 -200 -600
C/D 60 60 60 60 60
Probab. 60 0.2 0.3 0.3 0.1 0.1
The-100
Expected Value of Perfect Information
Decision Large rise Small rise No change Small fall Large fall
Gold 250
-100 100 200 300 0
Bond 250 200 150 -100 -150
Stock 500
500 250 100 -200 -600
C/D 60 60 60 60 60
Probab. 600.2 0.3 0.3 0.1 0.1
This additional information may assist in refining original probability estimates, and
help improve decision making.
39 TOM BROWN – Using Sample
Information
Tom can purchase econometric forecast results for $50.
The forecast predicts “negative” or “positive” econometric growth.
Statistics regarding the forecast are:
P(B|Ai)P(Ai)
P(Ai|B) =
P(B|A1)P(A1)+ P(B|A2)P(A2)+…+ P(B|An)P(An)
Indicator
Indicator11 Indicator
Indicator22
States
States Prior
Prior Conditional
Conditional Joint
Joint Posterior
Posterior States
States Prior
Prior Conditional
Conditional Joint
Joint Posterior
Posterior
ofofNature Probabilities Probabilities Probabilities Probabilites
Nature Probabilities Probabilities Probabilities Probabilites ofofNature Probabilities Probabilities Probabilities Probabilites
Nature Probabilities Probabilities Probabilities Probabilites
Large
LargeRise
Rise 0.2
0.2 0.8
0.8 0.16
0.16 0.286
0.286 Large
LargeRise
Rise 0.2
0.2 0.2
0.2 0.04
0.04 0.091
0.091
Small Rise
Small Rise 0.3
0.3 0.7
0.7 0.21
0.21 0.375
0.375 Small Rise
Small Rise 0.3
0.3 0.3
0.3 0.09
0.09 0.205
0.205
No Change
No Change 0.3
0.3 0.5
0.5 0.15
0.15 0.268
0.268 No Change
No Change 0.3
0.3 0.5
0.5 0.15
0.15 0.341
0.341
Small Fall
Small Fall 0.1
0.1 0.4
0.4 0.04
0.04 0.071
0.071 Small Fall
Small Fall 0.1
0.1 0.6
0.6 0.06
0.06 0.136
0.136
Large Fall
Large Fall 0.1
0.1 00 00 0.000
0.000 Large Fall
Large Fall 0.1
0.1 11 0.1
0.1 0.227
0.227
s6
s6 00 00 0.000
0.000 s6
s6 00 00 0.000
0.000
s7
s7 00 00 0.000
0.000 s7
s7 00 00 0.000
0.000
s8
s8 00 00 0.000
0.000 s8
s8 00 00 0.000
0.000
P(Indicator 1)
P(Indicator 1) 0.56
0.56 P(Indicator 2)
P(Indicator 2) 0.44
0.44
48 Expected Value of Sample Information
EVSI
This is the expected gain from making decisions based on Sample Information.
Revise the expected return for each decision using the posterior probabilities as
follows:
TOM
49 BROWN – Conditional Expected Values
EV(Gold|Positive) = 84 EV(Gold|Negative)
= 120
EV(Bond|Positive) = 180 EV(Bond|Negative)
= 65
EV(Stock|Positive) = 250 EV(Stock|Negative)
= -37
EV(C/D|Positive)
If the forecast is “Positive” = 60If the forecast
EV(C/D|Negative)
is “Negative”
= 60
Invest in Stock. Invest in Gold.
TOM
51 BROWN – Conditional Expected Values
Since the forecast is unknown before it is purchased, Tom can only calculate the
expected return from purchasing it.
Expected return when buying the forecast = ERSI = P(Forecast is
positive)(EV(Stock|Forecast is positive)) +
P(Forecast is negative”)(EV(Gold|Forecast is
negative))
= (.56)(250) + (.44)(120) = $192.5
52 Expected Value of Sampling
Information (EVSI)
The expected gain from buying the forecast is:
EVSI = ERSI – EREV = 192.5 – 130 = $62.5
Large Rise Small Rise No Change Small Fall Large Fall s6 s7 s8 EV(prior) EV(ind. 1) EV(ind. 2)
Gold -100 100 200 300 0 100 83.93 120.45
Bond 250 200 150 -100 -150 130 179.46 67.05
Stock 500 250 100 -200 -600 125 249.11 -32.95
C/D Account 60 60 60 60 60 60 60.00 60.00
d5
d6
d7
d8
Prior Prob. 0.2 0.3 0.3 0.1 0.1
Ind. 1 Prob. 0.286 0.375 0.268 0.071 0.000 #### ### ## 0.56
Ind 2. Prob. 0.091 0.205 0.341 0.136 0.227 #### ### ## 0.44
Ind. 3 Prob.
Ind 4 Prob.
RESULTS
Prior Ind. 1 Ind. 2 Ind. 3 Ind. 4
optimal payoff 130.00 249.11 120.45 0.00 0.00
optimal decision Bond Stock Gold
EVSI = 62.5
EVPI = 141
Efficiency= 0.44
54 6.6 Decision Trees
Le
to t us
Apply for variance
Hi r no con -30,000
ec
th
Co
on
su
lt ire side
st
= - ant a c r th
50 on e d
00 su ec
lta isi
nt on
60 BILL GALLEN - The Decision Tree
0.4
Apply for variance
-30,000
Let us consider the
decision to hire a Pre nial
De
dic -5000
consultant othing
0.6
N
t
Do
Buy land Apply for variance
-300,000 -30,000
Purc
hase
optio
-20,0 n
BILL GALLEN – 00
Apply for variance
115,000
Build Sell
ved -500,000 950,000
r o
App
Den ?
ied
-75,000
Sell
? 260,000
Co
ns
ult
an
tp
r ed
icts
an
a pp
ro va
l
64 BILL GALLEN - The Decision Tree
115,000
Build Sell
ved -500,000 950,000
r o
App
Den ?
ied
-75,000
Sell
? 260,000
115,000
Build Sell
ved -500,000 950,000
r o
App
Den ?
ied
-75,000
Sell
? 260,000
115,000
Build Sell
23 -500,000 24 950,000
25
r oved
App
22 Den ?
.7
ied
-75,000
Sell
?
.3 26 27
260,000
o t
ed
$20,000 Do n .7
rov
e
hir $58,000
App
Buy land; Apply
Hi pr oval for variance
re $20,000
p
r edicts a
P
.4
.3
D en
Pre
di cts
ied
den
ial $-5,000
.6 Sell
Do nothing land
$-75,000
BILL
70 GALLEN - The Decision Tree
Excel add-in: Tree Plan
BILL
71 GALLEN - The Decision Tree
Excel add-in: Tree Plan
72 6.7 Decision Making and Utility
Introduction
The expected value criterion may not be appropriate if the decision is a one-time
opportunity with substantial risks.
Decision makers do not always choose decisions based on the expected value
criterion.
A lottery ticket has a negative net expected return.
Insurance policies cost more than the present value of the expected loss the insurance
company pays to cover insured losses.
73 The Utility Approach
The technique provides an insightful look into the amount of risk the decision
maker is willing to take.
The concept is based on the decision maker’s preference to taking a sure payoff
versus participating in a lottery.
Determining
75 Utility Values
Indifference approach for assigning utility values
Suppose you are given the option to select one of the following two
alternatives:
Receive $Rij (one of the payoff values) for sure,
Play a game of chance where you receive either
The highest payoff of $Rmax with probability p, or
The lowest payoff of $Rmin with probability 1- p.
Determining
77 Utility Values
Indifference approach for assigning utility values
1-p Rmax
Rij
Rmin
1-p Rmax
Rij
Rmin
Example: s 1 s1
d1 150 100
d2 -50 140
s 1 s1
d1 150 100
d2 -50 140
U(100)=.7U(150)+.3U(-50) $150
$100
= .7(1) + .3(0) = .7
1-p
p -50
TOM
81 BROWN - Determining Utility Values
Data
The highest payoff was $500. Lowest payoff was -$600.
The indifference probabilities provided by Tom are
Payoff -600 -200 -150 -100 0 60 100 150 200 250 300 500
Tom wishes to determine his optimal investment Decision.
Prob. 0 0.25 0.3 0.36 0.5 0.6 0.65 0.7 0.75 0.85 0.9 1
82 TOM BROWN – Optimal decision
(utility)
Utility Analysis Certain Payoff Utility
-600 0
Large Rise Small Rise No Change Small Fall Large Fall EU -200 0.25
Gold 0.36 0.65 0.75 0.9 0.5 0.632 -150 0.3
Bond 0.85 0.75 0.7 0.36 0.3 0.671 -100 0.36
Stock 1 0.85 0.65 0.25 0 0.675 0 0.5
C/D Account 0.6 0.6 0.6 0.6 0.6 0.6 60 0.6
d5 0 100 0.65
d6 0 150 0.7
d7 0 200 0.75
d8 0 250 0.85
Probability 0.2 0.3 0.3 0.1 0.1 300 0.9
500 1
RESULTS
Criteria Decision Value
Exp. Utility Stock 0.675
83 Three types of Decision Makers
U(200)
U(150)
EU(Game)
The
Theutility
utilityofofhaving
having$150
$150on
onhand…
hand…
U(100)
…is
…islarger
largerthan
thanthe
theexpected
expectedutility
utility
ofofaagame
gamewhose
whoseexpected
expectedvalue
value
isisalso
also$150.
$150.
U(200)
U(150)
EU(Game) AArisk
riskaverse
aversedecision
decisionmaker
makeravoids
avoids
the
thethrill
thrillofofaagame-of-chance,
game-of-chance,
whose
whoseexpected
expectedvalue
valueisisEV,
EV,ififhe
he
U(100) can
canhave
haveEV EVononhand
handfor
forsure.
sure.
Furthermore,
Furthermore,aariskriskaverse
aversedecision
decision
maker
makerisiswilling
willingtotopay
payaapremium…
premium…
…to
…tobuy
buyhimself
himself(herself)
(herself)out
outofofthe
the
game-of-chance.
game-of-chance.
100 CE 150 200 Payoff
0.5 0.5
86
Utility
Risk Averse Decision Maker
ker
n Ma
s io
e ci
lD
utra
k Ne
Ris
Risk Taking Decision Maker
Payoff
87 6.8 Game Theory
The payoff is based on the actions taken by all the decision making players.
88 Classification of Games
By number of players
Two players - Chess
Multiplayer – Poker
By total return
Zero Sum - the amount won and amount lost by all competitors are equal (Poker among
friends)
Nonzero Sum -the amount won and the amount lost by all competitors are not equal
(Poker In A Casino)
By sequence of moves
Sequential - each player gets a play in a given sequence.
Simultaneous - all players play simultaneously.
89 IGA SUPERMARKET
Data
The weekly percentage gain in market share for IGA, as a function of advertising
emphasis.
Sentry's Emphasis
Meat Produce Grocery Bakery
IGA's Meat 2 2 -8 6
A gain in market share to IGA results in equivalent loss for Sentry, and vice versa
Emphasis
(i.e. a zero sum Produce
game) -2 0 6 -4
Grocery 2 -7 1 -3
91
To prevent a sure loss of market share, both IGA and Sentry should select the
weekly emphasis randomly.
Thus, the question for both stores is:
What proportion of the time each area should be emphasized by each store?
IGA’s
93
Linear Programming Model
Decision variables
X1 = the probability IGA’s advertising focus is on meat.
X2 = the probability IGA’s advertising focus is on produce.
X 3 = the probability IGA’s advertising focus is on groceries.
Sentry’s
advertising
emphasis
Sentry’s Linear Programming Model
95
Decision variables
Y1 = the probability Sentry’s advertising focus is on meat.
Y2 = the probability Sentry’s advertising focus is on
produce.
Y 3 = the probability Sentry’s advertising focus is on
groceries.
Y4 = the probability Sentry’s advertising focus is on
bakery.
Objective Function For Sentry
Minimize the changes in market share in favor of IGA
Sentry’s
96
perspective
Constraints
Sentry’s market share decrease for any given
advertising focus selected by IGA, must not exceed V.
The Model
Min V
S.T.
2Y1 + 2Y2 – 8Y3 + 6Y4 V
-2Y1 + 6Y3 – 4Y4 V
2Y1 – 7Y2 + Y3 – 3Y4 V
Y1 + Y2 + Y3 + Y4 = 1
For IGA
X1 = 0.3889; X2 = 0.5; X3 = 0.1111
For Sentry
Y1 = .3333; Y2 = 0; Y3 = .3333; Y4 = .3333
Worksheet: [IGA.xls]Sheet1
Adjustable Cells
Final Reduced Objective Allowable Allowable
Cell Name Value Cost Coefficient Increase Decrease
$A$2 X1 0.388888889 0 0 4 6
$B$2 X2 0.5 0 0 4 2
$C$2 X3 0.111111111 0 0 1.5 2
$D$2 V -6.75062E-29 0 1 1E+30 1
Constraints
Final Shadow Constraint Allowable Allowable
Cell Name Value Price R.H. Side Increase Decrease
$E$4 -1.11022E-16 -0.333333333 0 0 1E+30
$E$5 6.75062E-29 0 0 0 1E+30
$E$6 3.88578E-16 -0.333333333 0 1E+30 0
$E$7 -2.77556E-16 -0.333333333 0 1E+30 0
$E$8 1 0 1 0.000199941 1E+30
99
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