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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 !!

MS&E 252

MS&E 252

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