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- HO20-Decision Diagrams
- HO5-HW2 v2
- ProblemSession2
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- HO3-ProbQ
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- ProblemSession3
- ProblemSession7
- ProblemSession5
- HO13-HW4
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- HO9-MidtermLogistics
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- Final instructions Part1
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- Midterm
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- HO27-PracticeFinal2WS
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- HO7-HW3
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- ProblemSession5
- HO26-PracticeFinal1Sol
- ProblemSession1
- HO29-OtherDAClasses
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- Midterm
- MidtermSolutions
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- ProblemSession3
- ProblemSession7
- HO25-PracticeFinal1
- HO13-HW4
- HO23-HW6Solutions
- HO19-HW5Solutions
- Final Instructions Part2
- HO2-HW1
- HO27-PracticeFinal2WS
- HO12-HW3Solutions
- HO18-HW6
- HO17-CaseInstructions
- HO22-HW7
- HO26b-PF1Sols Erratum

1

MS&E 252

Decision Analysis I

Problem Session 4

2

Announcements

• Case Study Groups

– Start forming groups of 4 inside your problem

session;

– Email your TA by Monday, Nov. 8

th

, with the

names of your team members.

2

3

What concepts do we expect you to

master?

· Relevance

· Relevance Diagrams

· The Rules oI Arrow

Flipping

· Associative Logic

Errors

· The Five Rules of

Actional Thought

· Five Rules Problems

· U-Curves

· When do we need them?

· How do we use them?

4

In this class. we recommend that you

'Ily by the instruments.¨

· Instead oI trusting your

intuition. trust the calculations.

· Think oI pilots Ilying in Iog:

In good weather. beginners use the

instruments. and experts 'Ily by the

seat oI their pants¨ i.e. intuitively.

In Iog. even the experts use their

instruments.

With probabilitv. were alwavs flving in fog'

3

5

What are the ~Five Rules of Actional

Thought¨?

They are rules that ensure you will:

· Be consistent in your decisions.

· Have organized thought about the problem.

· Have the analytical ability to solve a problem

by breaking it down into small pieces.

If vou chose not to follow them... Then we cannot

help vou make a decision'

6

How to remember the Five Rules

· Probability rule

· Order rule

· Equivalence rule

· Substitution rule

· Choice rule

Mnemonic:

POE`S Choice

The rules prevent us from becoming a 'monev pump.` or someone

who can be rationallv convinced to give awav all of his or her assets.

The rules also dictate how we think about decisions.

4

7

The Probability Rule Iorces us to use

probabilities and prospects.

Because we characterize a situation using prospects. we

only care about things that will happen in the Iuture.

No sunk costs

No regret

The Wheel

We cant use other forms of representing

uncertaintv than probabilitv.

We cannot say 'I don`t know the probability¨ or 'There

is no probability.¨

RULE #1

8

>

X

The Order Rule Iorces us to compare

any two prospects.

'We can make a list of prospects. ordered

according to our preference (ties allowed).`

RULE #2

You can always create the necessary

distinctions to express preIerences. So

you must always be able to compare two

prospects.

You have to know what you want. or

you`ll become a money pump!

>

>

>

5

9

The Equivalence Rule Iorces us to state

indiIIerence between prospects and deals.

p

1-p

A

C

~

B

'Given prospects A ~ B ~ C. we can assign a

probabilitv p such that voure iust indifferent between B

and a deal with chance p of getting A. 1-p of getting C.`

RULE #3

The Wheel

10

The Equivalence Rule Iorces us to state

indiIIerence between prospects and deals.

No matter how

diIIicult. you must

be able to assign a

preIerence

probability.

~

Your current liIe

The Wheel

PerIect liIe

Instant.

painless death

Blue

Orange

p

1-p

'Given prospects A ~ B ~ C. we can assign a

probabilitv p such that voure iust indifferent between B

and a deal with chance p of getting A. 1-p of getting C.`

RULE #3

6

11

A Iew more notes

on the Equivalence Rule.

· PreIerence probabilities do not

describe a belieI about an uncertain

event; they only represent your

preIerences.

· The Clairvoyant cannot help you

with these probabilities. In Iact

nobody can!

>

12

· 'You`re not kidding¨ rule

· Connects preIerence

probabilities with probabilities

assigned to distinctions.

The Substitution Rule builds on the

Equivalence Rule.

'You can actuallv take vour preference probabilities.

and treat them as real probabilities'`

RULE #4

p

1-p

A

C

~

B

7

13

The Choice Rule dictates

our decisions Ior us.

p

1-p

A

B

q

1-q

A

B

Deal 1: Deal 2:

You can have an agent act Ior you!

You will always choose the deal with the highest probability oI

the prospect you like best!

'Given the following deals. if vou prefer A over B. and

p ~ q . then vou must choose deal 1 over deal 2.`

RULE #5

14

What concepts do we expect you to

master?

· Relevance

· Relevance Diagrams

· The Rules oI Arrow

Flipping

· Associative Logic

Errors

· The Five Rules oI

Actional Thought

· Five Rules Problems

· U-Curves

· When do we need them?

· How do we use them?

8

15

'Five Rules Problems¨

First strategy: Iind a trick.

$50

0.75

0.25

~

$100

$0

0.5

0.5

~

$35

$100

$0

Eunice has certain equivalents Ior two deals as Iollows:

Find her certain

equivalent Ior the

Iollowing deal:

0.25

0.375

$100

$0

0.25

0.125

$50

$35

16

'Five Rules Problems¨

First strategy: Iind a trick.

0.25

0.375

$100

$0

0.25

0.125

$50

$35

0.75

0.25

~

$100

$0

0.5

0.5

~

$100

$0

.25¹.25*.75¹.125*.5

.25*.25¹.125*.5¹.375

$100

$0

÷ .5

÷ .5

9

17

Let`s try it here is a typical 'Five

Rules Problem¨.

John preIers more money to less and has the

Iollowing certain equivalents:

0.5

0.5

~

$30

$100

$0

0.7

0.3

~

$50

$100

$0

0.6

0.4

~

$40

$50

$30

18

Let`s try it here is a typical

'Five Rules Problem¨

0.7

0.3

$50

$30

0.6

0.4

$40

$30

0.6

0.4

0.5

0.5

$100

$0

0.7

0.3

$50

$40

Deal A:

Deal B:

Deal C:

How should John rank these deals?

10

19

'Worksheet¨ Ior this problem.

0.5

0.5

~

$30

$100

$0

0.7

0.3

~

$50

$100

$0

0.6

0.4

~

$40

$50

$30

0.7

0.3

$50

$30

0.6

0.4

$40

$30

Deal A:

Deal B:

0.6

0.4

0.5

0.5

$100

$0

0.7

0.3

$50

$40

Deal C:

Step 1 Find the

Iundamental outcomes in

terms oI which you will

rewrite every deal.

Step 2 Plug the deals

whose certain

equivalents you know

into deals A. B. C.

Etc.

20

Second strategy: algebra!

Each deal represents an equation such as.

0.5

0.5

~

$30

$80

$20

means p

30

÷ 0.5p

80

¹ 0.5p

20

p

x

1- p

x

~

$x

$100

$0

where we deIine p

x

as

11

21

II you can`t Iind a trick. rank prospects.

Iind preIerence probabilities. and choose.

List and rank

prospects

$100

$50

$35

$0

p

100

÷ 1

p

50

p

35

p

0

÷ 0

Assign

preference

probabilities

0.75

0.25

~

$50

$100

$0

50 100 0

0.75 0.25 0.75 p p p = + =

0.5

0.5

~

$35

$100

$0

35 100 0

0.5 0.5 0.5 p p p = + =

22

II you can`t Iind a trick. rank prospects.

Iind preIerence probabilities. and choose.

List and rank

prospects

$100

$50

$35

$0

p

100

÷ 1

p

50

÷ 0.75

p

35

÷ 0.5

p

0

÷ 0

Assign

preference

probabilities

0.25

0.375

$100 1

$0 0

0.25

0.125

$50 0.75

$35 0.5

100 50 35 0

0.25 0.25 0.125 0.375

0.25 (0.25)(0.75) (0.125)(0.5)

0.5

$35

CE

p p p p p

CE

= + + +

= + +

=

=

12

23

What concepts do we expect you to

master?

· Relevance

· Relevance Diagrams

· The Rules oI Arrow

Flipping

· Associative Logic

Errors

· The Five Rules oI

Actional Thought

· Five Rules Problems

· U-Curves

· When do we need them?

· How do we use them?

24

How much do you value a deal?

· When Iaced with certainty people

value monetary deals the same.

· These types oI problems are easy to

solve and would have the Iorm:

· Do you preIer $1000 or $5000 ?

13

25

· People react diIIerently due to many Iactors:

their taste Ior risk

their wealth state

How much do you value a deal?

· When there is no uncertainty. we do not need u-values at all...

· . But people place diIIerent values on uncertain deals.

26

When we study risk preIerence. we

study U-curves.

'A persons risk preference (or risk attitude)

describes the relation between an uncertain deal and

that persons PISP and PIBP for the deal.`

TradeoII between greed and Iear

$150.000

-$75.000

0.5

~

?

Greed

Fear

14

27

Why do we need U-curves?

U-curves are a good

means Ior us to assess the

values people place on

uncertain deals.

In this session. we will show how to

assess the U-curves for different individuals.

28

Why do we use the term 'u-value¨

instead oI utility?

Utility

Value model

Kim

O - S

Kim

¹$100

~

u-curve

0.5

$100

$0

$34

15

29

One method of assessment is to follow a similar

procedure to Kims partv problem.

Arrange all prospects according to

the order rule .

Calculate the preIerence probability

oI each prospect.

This applies no matter how many

prospects you have.

How do we assess U-values?

> p?

>

30

Why can we scale and shiIt u-values?

u

1

p u

A

u

2

1 2

(1 )

A

u pu p u = + −

p u

B

a · bu

1

a · bu

2

1 2

1 2

1 2

1 2

( ) (1 )( )

(1 ) (1 )

( (1 )) ( (1 ) )

( (1 ) )

B

B

B

B

B A

u p a bu p a bu

u pa pbu p a p bu

u a p p b pu p u

u a b pu p u

u a bu

= + + − +

= + + − + −

= + − + + −

= + + −

= +

Deal A:

Deal B:

16

31

Using U-curves How do we 'roll

back¨ a tree?

0.4

0.6

S

R

0.95

0.32

.4*.95·.6*.32

Uncertainties:

Take e-value of u-values

÷ 0.63

Decisions:

Pick best u-value

O

I

0.40

0.63

0.57

P

÷ 0.57

Max(.4. .57. .63)

32

Using U-curves Finding a Certain

Equivalent graphically.

Example -

Finding the CE oI a deal with 50° chance oI $80 and

50° chance oI $10.

$100 $0 $80 $10

u($10)

u($80)

.5u($80)¹.5u($10)

÷ u(CE)

CE

17

33

Using U-curves Why is it important

to remember this construction?

· Reminds you that you should calculate

the e-value oI the u-values. not the e-

value of the dollar amounts placed on

the prospects.

· Can also be used to determine the Value

oI Clairvoyance (iterative construction).

'When faced with a decision tree. unless the decision maker

is risk-neutral. alwavs remember to go to u-space. then take

the e-value. then go back to $-space.`

34

Old Slides Revisited

ReIer to previous problem session slides

- ProblemSession6Uploaded byFernando Haro
- HO20-Decision DiagramsUploaded byFernando Haro
- HO5-HW2 v2Uploaded byFernando Haro
- ProblemSession2Uploaded byFernando Haro
- HO16-HW4SolutionsUploaded byFernando Haro
- HO19-HW5SolutionsUploaded byFernando Haro
- HO29-OtherDAClassesUploaded byFernando Haro
- ProblemSession8Uploaded byFernando Haro
- HO3-ProbQUploaded byFernando Haro
- HO10-PracticeMidtermUploaded byFernando Haro
- HO15-HW5Uploaded byFernando Haro
- HO18-HW6Uploaded byFernando Haro
- HO17-CaseInstructionsUploaded byFernando Haro
- ProblemSession3Uploaded byFernando Haro
- ProblemSession7Uploaded byFernando Haro
- ProblemSession5Uploaded byFernando Haro
- HO13-HW4Uploaded byFernando Haro
- HO23-HW6SolutionsUploaded byFernando Haro
- HO9-MidtermLogisticsUploaded byFernando Haro
- ProblemSession1Uploaded byFernando Haro
- Final instructions Part1Uploaded byFernando Haro
- HO8-HW2SolutionsUploaded byFernando Haro
- HO28-HW7SolutionsUploaded byFernando Haro
- MidtermUploaded byFernando Haro
- MidtermSolutionsUploaded byFernando Haro
- HO27-PracticeFinal2WSUploaded byFernando Haro
- HO12-HW3SolutionsUploaded byFernando Haro
- HO7-HW3Uploaded byFernando Haro
- HO22-HW7Uploaded byFernando Haro
- HO25-PracticeFinal1Uploaded byFernando Haro

- ProblemSession5Uploaded byFernando Haro
- HO26-PracticeFinal1SolUploaded byFernando Haro
- ProblemSession1Uploaded byFernando Haro
- HO29-OtherDAClassesUploaded byFernando Haro
- HO8-HW2SolutionsUploaded byFernando Haro
- HO28-HW7SolutionsUploaded byFernando Haro
- MidtermUploaded byFernando Haro
- MidtermSolutionsUploaded byFernando Haro
- HO10-PracticeMidtermUploaded byFernando Haro
- HO15-HW5Uploaded byFernando Haro
- ProblemSession3Uploaded byFernando Haro
- ProblemSession7Uploaded byFernando Haro
- HO25-PracticeFinal1Uploaded byFernando Haro
- HO13-HW4Uploaded byFernando Haro
- HO23-HW6SolutionsUploaded byFernando Haro
- HO19-HW5SolutionsUploaded byFernando Haro
- Final Instructions Part2Uploaded byFernando Haro
- HO2-HW1Uploaded byFernando Haro
- HO27-PracticeFinal2WSUploaded byFernando Haro
- HO12-HW3SolutionsUploaded byFernando Haro
- HO18-HW6Uploaded byFernando Haro
- HO17-CaseInstructionsUploaded byFernando Haro
- HO22-HW7Uploaded byFernando Haro
- HO26b-PF1Sols ErratumUploaded byFernando Haro