Chapter 13 - Short-term risk and uncertainty Flashcards
What is the difference between risk and uncertainty?
- Risk is quantifiable
- Uncertainty is unquantifiable
What do risk neutral decision makers focus on?
Expected value
What are the advantages of expected value?
- Takes account of risk
- Easy decision rule
- Simple
What are the disadvantages of expected value?
- Subjective
- Not useful for one-offs
- Ignores risk attitude
- Answers may not be possible
- Ignores spread of outcomes
What does a payoff table show?
All possible profits/losses
What does the standard deviation measure?
Compares all actual outcomes with expected value, then how far these deviate from mean
What is the standard deviation formula?
Say it!
When should decisions trees be used?
Where a problem involves a series of decisions being made and several outcomes arise during the decision making process
What is the formula for the expected value?
sum of (P x X)
X = future outcome
P = probability
What is standard deviation a measure of?
Volatility
What is the formula for the coefficient of variation?
Standard deviation/mean
What is the formula for special distribution (z)?
z = (x - mean)/standard deviation
x = variable
What is the maximax rule?
- Max payoff selected for each option
- Max of those chosen
Who does the maximax rule suit?
Optimists
What is the maximin rule?
- Min payoff chosen for each option
- Max of those chosen
Who does the maximin rule suit?
Pessimists
What is the minimax regret strategy?
Minimises max regret, useful when probabilities for outcomes aren’t available
How is the mimimax regret found?
- 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
How is the value of perfect info calculated?
Expected profit with info - expected profit without info
How is a decision tree drawn?
- Draw tree from L to R using symbols for decisions/events
- Evaluate tree from L to R, calc EV and choose best option along way
- Recommend course of action
What symbols are used on a decision tree?
- Squares - represent decision point
- Circles - chance outcome point, branches always subject to probability
What factors cause issues with decision trees?
- Assumes risk neutrality
- Sensitivity analysis
- Oversimplification
What does sensitivity analysis do?
takes each uncertain factor in turn and calcs change necessary before original decision is reversed
What are the advantages of sensitivity analysis?
- Info presented to management in subjective manner
- Identifies crucial areas of success
What are the disadvantages of sensitivity analysis?
- Assumes variables can be changed individually
- Only identifies how far a variable needs to change, not probability
- Doesn’t suggest a correct decision
