1

MS&E 252
Decision Analysis I
Problem Session 7
What concepts do we expect you to master?
· Probability Encoding
· 20 Questions
· Rain Bets
· Medical Decision
Analysis
· Micromort
· $-value per micromort
· Case Study
· Quantitative Problem
· A quick overview oI
MS&E 352 DA2
2
Why do we need probability encoding?
· Probability encoding is a process
that will help you elicit the
numbers you need Ior your
analysis.
· ThereIore. your analysis will be
as good as your probability
encoding was.
· But probability encoding can be
time-consuming and is Iull oI
traps.
What did vou learn from the 20 Questions?
1
2
3
4
7
8
9
10
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
0 20 40 60 80 100 120
1
'You think you know more than you do.¨
'People generallv tend to have distributions
that are too narrow.`
0
1
2
3
4
5
6
7
8
9
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82 85
· See the number oI
surprises in 20 Questions
exercise.
· Technically speaking. we
call this a ~Central Bias¨.
· To avoid it. you can use
backcasting.
3
'There are manv distinctions that can help vou
think about a distinction of interest.`
'You know more than you think you do.¨
US dog food
production
US Population
Avr. # oI
dogs per
home
How much
Iood does a
dog eat?
Etc.
Dog Iood
thrown
away
Consumption
oI dog Iood by
other pets
What concepts do we expect you to master?
· Probability Encoding
· 20 Questions
· Rain Bets
· Medical Decision
Analysis
· Micromort
· $-value per micromort
· Case Study
· Quantitative Problem
· A quick overview oI
MS&E 352 DA2
4
What do we call the Rain Bet?
· Suppose that vou can find two people
who have different beliefs about some
uncertaintv.
· Then vou can set up a deal in which thev
will lose or gain monev from the other
person depending on the outcome of this
uncertaintv. and this deal will also look
appealing to both of them.
· You can even make monev out of them'
We set up a bet that both
Alex and Ted will Iind appealing.
Alex Ted
¦R ' &
Alex
} ÷ 0.7 ¦R ' &
Ted
} ÷ 0.2
Rain
No Rain
Rain
No Rain
0.7 0.2
$5.50
-$4.50
$4.50
-$5.50
$2.50 ~ $2.50 ~
Both could actuallv be willing to pav up to $2.50 to get the deal'
5
Let us reveal
what was hidden behind this bet.
Alex Ted
¦R ' &
Alex
} ÷ p ¦R ' &
Ted
} ÷ q · p
Rain
No Rain
Rain
No Rain
p q
$ m
-$ (K-m)
$ (K-m)
-$ m
mp -
(1-p).(K-m)
- qm +
(1-q).(K-m)
m ÷ K ` (2 - p - q) / 2
Additional remarks on the Rain Bet.
· Their CE is the maximum amount you
could charge them Ior the deal.
· You could make K. the total amount at
stake. as high as you wish. but then you
would need to account Ior risk-attitude.
· In the previous example. we set K÷10
and then inIerred the corresponding
value oI m.
· . But you could also have inIerred the
value oI m Ior some value oI their CE.
6
What concepts do we expect you to master?
· Probability Encoding
· 20 Questions
· Rain Bets
· Medical Decision
Analysis
· Micromort
· $-value per micromort
· Case Study
· Quantitative Problem
· A quick overview oI
MS&E 352 DA2
Medical Decision Analysis
· Some problems with Medical
Decision making :
Procedures are generalized Ior all
individuals not taking into consideration
their own preIerences.
Moreover. Iew decisions are actually
made by the patient.
Medical Decision Analysis provides us with a Iramework
that can help us tackle liIe and death issues.
7
.
24 hour Pain. then Cure
B
A
Pay a certain amount X. then Cure
We calculate your micromort value by
setting up two deals. (1)
You should be iust indifferent between the two alternatives
vou are measuring vour PIBP for pain relief.
.
p
1-p
24 hour Pain. then Cure
Cure
Death
C
A
We calculate your micromort value by
setting up two deals. (2)
Again. vou should be iust indifferent.
P cannot be 0 why? P cannot be 1 why?
8
p
1-p
24 hour Pain. then cure
Cure
Death
C
A
Pay a certain amount X. then cure
We calculate your micromort value by
setting up two deals. (3)
B
Form the ratio
(X/p)/1.000.000
The ratio (X/p)/1.000.000 is vour $-value per micromort.
Indifference
Why do we evaluate micro-probabilities?
· A micromort is a chance of one
in a million of dving.
· This unit is usuallv more
appropriate when we cope with
life and death issues.
· We are interested in evaluating
the dollar value per micromort
($/µmt).
9
Micromorts provide us with a scale
against which it is natural to assess risks.
Such a table is very useIul to measure a certain level oI
risk against risks you are more Iamiliar with.
Proba of Death
Type of Accident in mt year, in the US
Motor Vehicle 270
Falls 100
Fire and Explosion 40
Drowning 28
Firearms 13
Machinery 10
Aircraft 7.5
Why is the value per micromort useIul?
There is a range of small risks over which these two
curves are linear.
Payment to Avoid Death Risk
1
10
100
1000
10000
100000
1000000
10000000
100000000
0 0 1 10 100 1,000 10,000 100,000 1,000,000
Micromorts (1 in a million chance at death)
P
a
y
m
e
n
t

(
$
)
Payment to Accept Death Risk
1
10
100
1000
10000
100000
1000000
10000000
100000000
0 0 1 10 100 1,000 10,000 100,000 1,000,000
Micromorts (1 in a million chance at death)
P
a
y
m
e
n
t

(
$
)
10
Here is a simple example showing how you
would use the constant range.
· Leo is your typical American; as
such. he considers he Iaces 270 µmt
a year Irom auto accidents.
· His value per micromort in the
constant range is about $20.
· How much should he be willing to
pay Ior a Iull 'auto death prevention¨
policy?
Answer: 20 ` 270 ÷ $5.400 a year!
Why did we have the 24-hour
pain alternative?
· To give you an incentive to put
down a number.
· To be a transition stage between
the two other alternatives
some people do not Ieel
comIortable with the concept oI
trading a probability oI death
with money.
11
What concepts do we expect you to master?
· Probability Encoding
· 20 Questions
· Rain Bets
· Medical Decision
Analysis
· Micromort
· $-value per micromort
· Case Study
· Quantitative Problem
· A quick overview oI
MS&E 352 DA2
Here is what we expect Irom you.
The due date is Thursday. December 2
nd
.
· 1 page executive summary. aimed at
someone who is not Iamiliar with DA.
· Report consists oI a series oI slides (no
more than 15). excluding appendices.
· Organize the appendix in the order
Formulate Evaluate Appraise Decide.
12
Let us think about the tools you might
need Ior this case.
You are encouraged to take initiatives. as long as vou
make vour assumptions explicit.
Distinctions
Relevance &
Decision
Diagrams
Probability
Tree / Decision
Tree
Sensitivity
Analysis
Value oI
InIormation
Best
Alternative
& CE
Etc.
This case will give you a Ilavor oI what
applying DA in the real world is like.
· The decision maker will not always have
time to give you accurate assessments.
· There are even situations in which the
decision maker may not be comIortable
making some assessments.
· In other cases. you might have to work
with numbers that contradict one another.
1ust like in real life.
13
What concepts do we expect you to master?
· Probability Encoding
· 20 Questions
· Rain Bets
· Medical Decision
Analysis
· Micromort
· $-value per micromort
· Case Study
· Quantitative Problem
· A quick overview oI
MS&E 352 DA2
Meet Debbie. the game show contestant.
· Debbie. a risk-neutral game show contestant. has won $400. She
may keep it. or spend it on a coin-tossing game.
· II the coin lands "heads" Debbie wins $750
and the game ends. II it lands "tails" she
wins a consolation prize oI $250. which she
then may trade Ior a die-rolling game.
· II the die roll is a 5 or a 6. Debbie wins
$1200; otherwise she wins nothing.
· Answer the following:
What is Debbie's CE for this entire deal?
What is the value of Clairvovance on the die roll?
What is the value of Clairvovance on the coin toss?
14
Draw a decision diagram Ior Debbie.
$
Keep Cash /
Toss Coin
Heads /
Tails
Die Roll
Consolation Prize /
Roll Die
What is Debbie`s CE Ior the entire deal?
Does she play the game?
1/2
1/2
$1200
$0
1/3
2/3
$400
$250
Else
5 or 6
Roll Die
Consolation Prize
$750
Toss Coin
Cash
Tails
Heads
$400
$575
How sensitive is the decision to the 'Heads` value?
Remember
Hamlet!
15
We can graph the CE Ior the deal as a
Iunction oI this payoII.
Sensitivity to Value of Payoff if Heads
$0
$100
$200
$300
$400
$500
$600
$700
$800
$0 $100 $200 $300 $400 $500 $600 $700 $800 $900 $1,000
Payoff 1
C
e
r
t
a
i
n

E
q
u
i
v
a
l
e
n
t
Toss Coin
Cash
Best
Now let`s think about the sensitivity to the
probability oI a winning die roll.
1/2
1/2
$1200
$0
1/3
2/3
$400
$250
Else
5 or 6
Roll Die
Consolation Prize
$750
Toss Coin
Cash
Tails
Heads
$400
$575
How sensitive is the decision to this probabilitv?
p
16
1200 . p · 0 . (1-p) ÷ 250
1200 . p ÷ 250
p ÷ 0.21
What is the sensitivity to the
probability oI a winning die roll?
1/2
1/2
$1200
$0
p
1 - p
$400
$250
Else
5 or 6
Roll Die
Consolation Prize
$750
Toss
Coin
Cash
Tails
Heads Crossing point between 'Roll
Die¨ and 'Consolation Prize¨
p will affect Debbie`s
decision to roll the die or not.
?
You do not need to compute
anvthing'
She will never go for 'Cash`'
What is the sensitivity to the
probability oI a winning die roll?
1/2
1/2
$1200
$0
p
1 - p
$400
$250
Else
5 or 6
Roll Die
Consolation Prize
$750
Toss
Coin
Cash
Tails
Heads Crossing point between 'Toss
Coin¨ and 'Cash¨
p will NOT affect Debbie`s
decision to toss the coin or not.
?
17
This also shows on this graph.
Sensitivity to Proba of 5 or 6
$0
$200
$400
$600
$800
$1,000
$1,200
0.00 0.10 0.20 0.30 0.40 0.50 0.60 0.70 0.80 0.90 1.00
Proba of 5 or 6
C
e
r
t
a
i
n

E
q
u
i
v
a
l
e
n
t
Toss + Consolation
Toss + Roll
Cash
Best
Remember that you can also perIorm
Sensitivity Analysis on v.
1/2
1/2
$1200
$0
1/3
2/3
$400
$250
Else
5 or 6
Roll Die
Consolation Prize
$750
Toss
Coin
Cash
Tails
Heads
How do you think v will inIluence
Debbie`s decisions?
· Debbie is risk neutral what
does she do?
· What iI she was inIinitely risk-
seeking?
· What iI she was inIinitely risk-
averse?
18
Our intuition is conIirmed by the
Iollowing graph.
Sensitivity to Gamma
$0
$200
$400
$600
$800
$1,000
$1,200
$1,400
-0.07 0.03
Gamma
C
e
r
t
a
i
n

E
q
u
i
v
a
l
e
n
t
Toss Coin
Cash
What is the Value oI Clairvoyance on
the outcome oI the coin toss?
1/2
1/2
$1200
$0
1/3
2/3
$400
$250
Else
5 or 6
Roll Die
Consolation Prize
$750
Toss
Coin
Cash
Tails
Heads
Suppose the Clairvoyant`s
report says 'Heads¨ what
should she do?
Suppose the Clairvoyant`s
report says 'Tails¨ what
should she do?
What can vou infer from this?
19
Now iI you want to do the
calculations.
Value of Clairvoyance $0
$-value u-value
>>> Toss Coin
0.5 $750 0.75
Heads 0.75
1
0.75
Cash
$400 0.40
0.40
0.33
5 or 6
$1,200 1.20
>>> Roll Die 1.20
0.58
$575 0.40 0.67
1, 2, 3 or 4
>>> Toss Coin $0 0.00
1 0.00
0.40
0.5
Tails Consolation Prize
1 $250 0.25
0.40 0.25
Cash
$400 0.40
0.40
This also savs that Debbie should not even bother about a detector.
What about Clairvoyance on the
outcome oI the die roll?
1/2
1/2
$1200
$0
1/3
2/3
$400
$250
Else
5 or 6
Roll Die
Consolation Prize
$750
Toss
Coin
Cash
Tails
Heads
Suppose the Clairvoyant`s
report says '5 or 6¨ what
should she do?
Suppose the Clairvoyant`s
report says '1. 2. 3 or 4¨
what should she do?
This time we need to
struggle with the numbers'
20
Computing the Value oI Clairvoyance
on the outcome oI the Die Roll
Value of Clairvoyance $83 0.5 $-value u-value
Heads
$750 0.75
0.75
>>> Toss Coin
0.98 >>> Roll Die
0.5 $1,200 1.20
Tails 1.20
0.33 1
5 or 6 1.20
1 Consolation Prize
0.98 $250 0.25
0.25
Cash
$400 0.40
0.40
0.5
Heads
0.66 $750 0.75
$658 0.75
>>> Toss Coin
0.50 Roll Die
0.5 $0 0.00
Tails 0.00
0.67 2
1, 2, 3 or 4 0.25
1 >>> Consolation Prize
0.50 $250 0.25
0.25
Cash
$400 0.40
0.40
The VoC is
here!
Last what about the Value oI
Clairvoyance on both uncertainties?
1/2
1/2
$1200
$0
1/3
2/3
$400
$250
Else
5 or 6
Roll Die
Consolation Prize
$750
Toss
Coin
Cash
Tails
Heads
A nice probabilistic question
Do vou expect the JoC on both
uncertainties to be.
a) Equal to the sum oI the
individual VoC`s?
b) Less than the sum?
c) Greater than the sum?
21
The VoC on both uncertainties turns out to be
greater than the sum oI the individual VoC`s.
Value of Clairvoyance $133
0.17 $-value u-value
Heads and 5 or 6 >>> Toss Coin
1 $750 0.75
0.75 0.75
0.33
Heads and 1, 2, 3 or 4 >>> Toss Coin
1 $750 0.75
0.75 0.75
0.71 0.17
$708 Tails and 5 or 6 >>> Toss and Roll
1 $1,200 1.20
1.2 1.20
0.33
Heads and 1, 2, 3 or 4 >>> Cash
1 $400 0.40
0.4 0.40
Watch out for common misconceptions about JoC'
What concepts do we expect you to master?
· Probability Encoding
· 20 Questions
· Rain Bets
· Medical Decision
Analysis
· Micromort
· $-value per micromort
· Case Study
· Quantitative Problem
· A quick overview oI
MS&E 352 DA2
22
Most oI the quantitative tools oI Decision
Analysis are actually covered in DA2.
Deterministic
Analysis
Probabilistic
Analysis
Appraisal Structure
Ioice IieId Diagians &
Issue Raising
Decision Hieiaichv
Slialegv TalIes
Decision Diagians
Spieadsheel ModeI
1997
NIV
1
2
3
4
1998 1998
Sensilivilv lo Range
Decision Tiees
IiolaliIilv Disliilulions
and Doninance
High-ßase-Lov of
IiolaliIilv disliilulions
AIl 1
AIl 2
AIl 3
Sensilivilv AnaIvsis
VaIue of Infoinalion
Decision OuaIilv
VaIue of ConlioI
p
1-p
1
O
Deleininislic Sensilivilv
Formulate Evaluate Appraise
Decide
Miscellaneous topics that will be
addressed in DA2.
-$0.50
-$0.30
-$0.10
$0.10
$0.30
$0.50
$0.70
$0.00
$5.00
$10.00
$15.00
$20.00
$25.00
$30.00
$35.00
$40.00
$45.00
$50.00
$55.00
$60.00
· Auctions and Bids
· Winner`s Curse
· Knowledge Maps
· And a lot of Case Studies!
· Influence Arrows. Information
· Open Loop / Closed Sensitivity
· Medical DA
· Multiattribute Utility
· Framing. Options. Dominance
23
Announcements
• Homework 7 due on Tuesday, Nov 30
th
• Case study due on Thursday, Dec 2
nd
• Have a great Thanksgiving !!

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