Chapter 13 - Short-term risk and uncertainty

Question 1

What is the difference between risk and uncertainty?

Answer 1

• Risk is quantifiable
• Uncertainty is unquantifiable

Question 2

What do risk neutral decision makers focus on?

Answer 2

Expected value

Question 2

What are the advantages of expected value?

Answer 2

• Takes account of risk
• Easy decision rule
• Simple

Question 3

What are the disadvantages of expected value?

Answer 3

• Subjective
• Not useful for one-offs
• Ignores risk attitude
• Answers may not be possible
• Ignores spread of outcomes

Question 4

What does a payoff table show?

Answer 4

All possible profits/losses

Question 5

What does the standard deviation measure?

Answer 5

Compares all actual outcomes with expected value, then how far these deviate from mean

Question 6

What is the standard deviation formula?

Answer 6

Say it!

Question 7

When should decisions trees be used?

Answer 7

Where a problem involves a series of decisions being made and several outcomes arise during the decision making process

Question 8

What is the formula for the expected value?

Answer 8

sum of (P x X)

X = future outcome
P = probability

Question 9

What is standard deviation a measure of?

Answer 9

Volatility

Question 10

What is the formula for the coefficient of variation?

Answer 10

Standard deviation/mean

Question 11

What is the formula for special distribution (z)?

Answer 11

z = (x - mean)/standard deviation

x = variable

Question 12

What is the maximax rule?

Answer 12

• Max payoff selected for each option
• Max of those chosen

Question 13

Who does the maximax rule suit?

Answer 13

Optimists

Question 14

What is the maximin rule?

Answer 14

• Min payoff chosen for each option
• Max of those chosen

Question 15

Who does the maximin rule suit?

Answer 15

Pessimists

Question 16

What is the minimax regret strategy?

Answer 16

Minimises max regret, useful when probabilities for outcomes aren’t available

Question 17

How is the mimimax regret found?

Answer 17

• Find maxpayoff in each demand row
• For each supply level, compare actual payoff with what could’ve been earned, difference is regret
• Create regret table
• Determine max regret for each supply level
• Supply which produces min of those values is minimax regret

Question 18

How is the value of perfect info calculated?

Answer 18

Expected profit with info - expected profit without info

Question 19

How is a decision tree drawn?

Answer 19

1. Draw tree from L to R using symbols for decisions/events
2. Evaluate tree from L to R, calc EV and choose best option along way
3. Recommend course of action

Question 20

What symbols are used on a decision tree?

Answer 20

• Squares - represent decision point
• Circles - chance outcome point, branches always subject to probability

Question 21

What factors cause issues with decision trees?

Answer 21

• Assumes risk neutrality
• Sensitivity analysis
• Oversimplification

Question 22

What does sensitivity analysis do?

Answer 22

takes each uncertain factor in turn and calcs change necessary before original decision is reversed

Question 23

What are the advantages of sensitivity analysis?

Answer 23

• Info presented to management in subjective manner
• Identifies crucial areas of success

Question 24

What are the disadvantages of sensitivity analysis?

Answer 24

• Assumes variables can be changed individually
• Only identifies how far a variable needs to change, not probability
• Doesn’t suggest a correct decision