Asset Management 2 Flashcards
Daniel Bernoulli
most prominent scholar to research the theory of a good decision
- expected value = (odds of gain) x (value of gain)
two errors in decision making that people make
- error in odds
- error in value
Error in odds
- we use past experiences to estimate odds
Error in value
- value is harder to estimate than odds
- comparisons change the way we value things
(supermarket example and concert ticket example) - about 90-95% of our decisions made on emotional instinctual levl
Why we make bad decisions
- brains evolved for a different world than we live in (highest priority to eat and mate)
- must learn how to un-learn our natural instinct
- this is why we rely on experts for important decisions
MCA
Multi Criteria Analysis
- decision techniquie that considers more than one criterion
- commonly used where benefit to cost ratios are difficult to accurately define
Advantages of MCA
- fast and dirty approaxh
- tool can be combined with others to become very powerful
Disadvantages of MCA
- weighting factors often difficult to agree on by many parties
- may be inconsistencies within weighting factors
MCA Method
- Select Decision Criteria or Indicators
- Identify weightings for each indicator
- Assess indicator value for each option
- Calculate overall results
AHP
Analytical Hierachy Process
- in-depth pairwise comparison method
- developed by Thomas Saaty in 1980s
Advantages of AHP
- based on Mathematical Decision Theory and is an industry standard
- generates ratio data
Disadvantages of AHP
- labour intensive
- participants perceive the tool as a ‘black box’ if they do not understand the mathematical theory
Risk Based Decision Making
risk = probability x consequence
- uses this technique to identify high risk areas that should be addressed
- risk often used to balance the funding gap
- understanding this gap will lead to better decision making
- powerful when combined with Monte Carlo analysis
AHP Method
- Define objective and decision options
- Structure elements in criteria, sub-criteria, alternatives
- Make pairwise comparisons of elements in each group
- Calculate weighting and consistency ratio
- Evaluate alternatives according to weighting
- Evaluate Benefit Cost Analysis (BCA)
- Make Decision
BCA
Benefit Cost Analysis
Cognitive Fluency
how easy an idea is to process and understand
- e.g. stockmarket tags: SKY TAG vs PHJ KJM`
Sunk Cost Fallacy
not leaving a bad movie before it ends as you feel that you paid for it
- lose $20 ticket AND time, but if leave only lose $20 ticket
- should focus on future costs/benefits
Self Serving Bias
if we win it is our success, if we lose it is someone else’s fault
- e.g. famous people vs you going to heaven
- research shown when operating in groups decisions are more rational
pseudo diagnostic information
- information that you see that isn’t really relevant but you think it is
- you see there is a correlation and imply there is causation
subtlety diagnostic information
information that is important but you dont think it is
Sorting Relevance
be aware of conformation bias: once you have decided on something, new information has less of an impact
- you either blow it off
- or you interpret information so that it is favourable to you
Inside view
always optimistic and thinks things are great
outside view
often gives a less optimistic view
think up-down
aims - conclusions
actions - causes
