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Lecture 8

BU275 Lecture 8: BU-275 Lecture 8

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David Wheatley

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BU-275Lecture8 Intro to Decision Analysis Payoff Tables and Decision Making under Uncertainty You have the opportunity to co-op for a friends start-up, working part-time or full-time and even invest in the company. States of Nature Company Takes Off Company does bad Alternatives Part Time 40,000 20,000 Full Time 70,000 10,000 Full Time and 110,000 -10,000 Investment The choices you have are called alternatives. The outcomes are determined by states of nature and each combo has a payoff If we can assign probabilities to the states of nature (events), then we can use expected value calculations. o Unfortunately, we may not have any idea what probabilities to assign, even if you have historical (empirical) data, it may not be applicable in your case Decision Making without Probabilities Decision Criteria: o Maximax (optimistic) Find the best payoff by alternative Pick the highest best case o Maximin (pessimistic) Find the worst payoff by alternative, and pick the highest (worst case) Safest choice o Minimax Regret First, we need a regret table, built by finding the best payoff by state of nature, the calculating regret in $ for the other payoffs What you could have had minus what you have = regret By alternative, find the largest regret, then pick the option whose worst-case regret is the smallest Substitutes for Probabilities o Equal likelihood criterion Here use 50% for each and calculate the expected value o Hurwicz Criterion Use , a coefficient of optimism (=1 is optimistic, =0 is pessimistic) Assign to best case, and 1- to the worst case Ex. =0.4, Best case*(0.4)+Worst case*(0.6)=Expected Value Decision Making with Probabilities: o Expected Value of an alternative: (Probability)*(Payoff) Find the
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