DECISION

MAKING UNDER
UNCERTAINTY
Topics to be 1. Criterion for realism (Hurwicz
Criterion)

discussed: 2. Equally likely (Laplace)

3. Minimax regret

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 is a compromise between an optimistic and a pessimistic decision.
Criterion for
realism
(Hurwicz)

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 Coefficient of realism α, 0 < α < 1
Criterion for
realism
(Hurwicz)

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 α is close to 1 (optimistic)

Criterion for α is close to 0 (pessimistic)

realism Example:

(Hurwicz) Alternatives Growing Stable Declining

Bonds 40 45 5

Stocks 70 30 -13

Mutual Funds 53 45 -5

α(best payoff) + (1- α)(worst payoff)

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Criterion for
realism Example: α = 0.3 1- α = 0.7

(Hurwicz) Alternatives Growing Stable Declining WEIGHTED AVERAGE:

Bonds 40 45 5 0.3(45) + 0.7(5)= 17.0

Stocks 70 30 -13 0.3(70) + 0.7(-13)= 11.9
Mutual Funds 53 45 -5 0.3(53) + 0.7(-5)= 12.4

α(best payoff) + (1- α)(worst payoff)

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Criterion for
realism Example: α = 0.3 1- α = 0.7

(Hurwicz) Alternatives Growing Stable Declining WEIGHTED AVERAGE:

Bonds 40 45 5 0.3(45) + 0.7(5)= 17.0

Stocks 70 30 -13 0.3(70) + 0.7(-13)= 11.9
Mutual Funds 53 45 -5 0.3(53) + 0.7(-5)= 12.4

Decision: Invest in Bonds

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 involves finding the average payoff for each alternative, and
Equally likely selecting the alternative with the best or highest average.
(Laplace) Example:
Alternatives Growing Stable Declining

Bonds 40 45 5
=
 
Stocks 70 30 -13

Mutual Funds 53 45 -5

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 involves finding the average payoff for each alternative, and
Equally likely selecting the alternative with the best or highest average.
(Laplace) Example:
Alternatives Growing Stable Declining AVERAGE:

Bonds 40 45 5 (40+45+5)/3= 30
Stocks 70 30 -13 (70+30-13)/3= 29
Mutual Funds 53 45 -5 (53+45-5)/3= 31

Decision: Invest in Mutual Funds

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 Minimum of Maximum regrets.
Minimax
Regret Example:
Alternatives

12 -5

15 11

5 18

Regret= Payoff Received – Best Payoff

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 Minimum of Maximum regrets.
Minimax
Regret Example:
Alternatives

12 -5

15 11

5 18

Regret
  if is already chosen= 12-5= 7
Regret
  if is already chosen= 15-5= 10
 Regret if is already chosen= 5-5= 0

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 Minimum of Maximum regrets.
Minimax
Regret Example:
Alternatives

12 -5

15 11

5 18

Regret
  if is already chosen= -5 – (-5)= 0
Regret
  if is already chosen= 11-(-5)= 16
 Regret if is already chosen= 18-(-5)= 23

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