Probability the language of uncertainty Flashcards
Net Present Value (NPV)
is a financial-calculation technique used to value a series of future cash in-flows (revenues) and cash out-flows (costs) by discounting them back to the present.
The danger is that in many business decisions under uncertainty are:
_____ single scenario estimates are used instead of probability estimates
No single number estimates can:
____ account for downside risk and upside opportunity
Single scenario estimates are
____ inadequate to reach sound conclusions
Probability
is the best way to account for uncertainty
Decision-relevant information
________ is obtained from subject matter experts (SMEs) and probabilities are used to model uncertainty
Primary Source
Obtained from interviewing SMEs using probability-encoding procedures
•Uncertainty of a continuous variable is modeled using discrete approximation methods
Secondary Source
•Obtained from SMEs and/or from observed/historical data
•Uncertainty of a continuous variable is modeled using
odiscrete approximation methods when n > 10
oMonte Carlo simulation (uniform) when n < 10
Information obtained on continuous variables
_____ often results in a s-shaped cumulative distribution function (CDF).
Subject Matter Experts
______ often overestimate their expertise resulting in a probability distribution that is too narrow.
Overconfidence
is failing to collect key factual information because the subject matter expert is too sure of their judgment
Motivating, Structuring, Conditioning, Encoding
Probability-encoding procedures
Motivating
Introduce task and identify motivational biases
Structuring
Establish definition of variable and assumptions
Conditioning
Counteract cognitive biases
