Opportunity Loss

Opportunity loss is the difference between an actual payoff for an

action and the optimal payoff, given a particular event

Investment Choice
Profit in $1,000’s (Action)
Payoff
(Events)
Large Factory Average Small Factory
Table
Factory

Strong Economy 200 90 40

Stable Economy 50 120 30
Weak Economy -120 -30 20
The action “Average factory” has payoff 90 for “Strong Economy”. Given “Strong Economy”,
the choice of “Large factory” would have given a payoff of 200, or 110 higher. Opportunity
loss = 110 for this cell.
 Opportunity Loss
Investment Choice (Action)
Profit in $1,000’s Payoff
(Events) Large Average Small
Factory Factory Factory Table

Strong Economy 200 90 40

Stable Economy
Weak Economy
50
-120
120
-30
30
20
Opportunity
Loss Table
Investment Choice (Action)
Opportunity Loss in
$1,000’s Large Average Small
(Events) Factory Factory Factory

Strong Economy 0 110 160

Stable Economy 70 0 90
Weak Economy 140 50 0
 Decision Criteria
 Expected Monetary Value (EMV)
 The expected profit for taking action Aj

 Expected Opportunity Loss (EOL)

 The expected opportunity loss for taking action Aj
 Expected Monetary Value
Goal: Maximize expected value
 The expected monetary value is the weighted average
payoff, given specified probabilities for each event
N
EMV ( j )   X ij Pi
i 1

Where EMV(j) = expected monetary value of action j

Xij = payoff for action j when event i occurs
Pi = probability of event i
 Expected Monetary Value
 The expected value is the weighted average
payoff, given specified probabilities for
each event
Investment Choice Suppose these
Profit in $1,000’s (Action) probabilities
(Events)
Large Average Small Factory have been
Factory Factory assessed for
these three
Strong Economy (0.3) 200 90 40 events
Stable Economy (0.5) 50 120 30
Weak Economy (0.2) -120 -30 20
 Expected Monetary Value
Payoff Table:
Investment Choice
Profit in $1,000’s (Action)
(Events)
Large Average Small Factory
Factory Factory

Strong Economy (0.3) 200 90 40

Stable Economy (0.5) 50 120 30
Weak Economy (0.2) -120 -30 20
EMV (Expected Values) 61 81 31

 Example: EMV (Average factory) = 90(.3) + 120(.5)

+ (-30)(.2) = 81
 Expected Opportunity Loss
Goal: Minimize expected opportunity loss

 The expected opportunity loss is the weighted average

loss, given specified probabilities for each event

N
EOL(j)   L ijPi
i 1

Where EOL(j) = expected monetary value of action j

Lij = opportunity loss for action j when event i occurs
Pi = probability of event i
 Expected Opportunity Loss
Opportunity Loss Table
Investment Choice (Action)
Opportunity Loss in
$1,000’s Large Average Small
Factory Factory Factory
(Events)

Strong Economy (0.3) 0 110 160

Stable Economy (0.5) 70 0 90
Weak Economy (0.2) 140 50 0

Expected Opportunity Loss 63 43 93

(EOL)

 Example: EOL (Large factory) = 0(.3) + 70(.5) +

(140)(.2) = 63