Question 6

Q6a

ALTERNATIVES STATE OF NATURE MAXIMUM MINIMUM

PAYOFF PAYOFF

S1 S2 S3 S4

A1 18 12 15 8 18 8

A2 15 14 10 11 15 10

A3 13 16 19 15 19 13

6a

i) Using the Maximin criterion, decision A3 should be recommended because it has the
highest minimum payoff.
ii) Using the Maximax criterion, decision A 3 should be recommended because it has the
highest maximum payoff.

ii) using the minimax regret criterion, a regret table is needed

regret=best payoff for a decision−received payoff for a decision

ALTERNATIVES STATE OF NATURE Maximum regret

S1 S2 S3 S4
A1 0 (18-18) 6 (18-12) 3 (18-15) 10 (18-8) 10

A2 0 (15-15) 1 (15-14) 5 (15-10) 4 (15-11) 5

A3 6 (19-13) 3 (19-16) 0 (19-19) 4 (19-15) 6

Answer: Using the minimax reject criterion, decision A 2 should be recommended since it has the lowest
maximum regret.

iii) Using Hurwicz rule with α=0.6, find the weighted average for each action and pick the
one with the maximum value.
For A1;
weighted average=α ( maximum payoff ∈row ) +(1−α )( minimum payoff ∈row)
weighted average=0.6 ( 18 ) +(1−0.6)(8)
weighted average=10.8+3.2=14
 For A2;

weighted average=0.6 ( 15 ) +(1−0.6)(10)

weighted average=9+ 4=13
For A3; weighted average=0.6 ( 19 ) +(1−0.6)(13)
weighted average=11.4+5.2=16.6
Thus, decision A3 should be recommended.

Q6(b)

X K100 K250 f y ( y)
Y

K0 0.20 0.05 0.25

K100 0.10 0.15 0.25

K200 0.20 0.30 0.50

f x ( x) 0.50 0.50 1

i) P ( X=K 100 , Y =K 200 ) =0.2

ii) P ( Y ≥ K 100 )=P ( Y =K 100 ) + P ( Y =K 200 )=0.25+0.50=0.75

iii) if the two are independent, then;

P ( X=x , Y = y )=P ( X =x ) P ( Y = y )
Using X=K100 and Y=K100

P ( X=K 100 , Y =K 100 )=0.10

And

P¿
Answer; the two variables are not independent because changing one does affect the other.

P(X =K 100 ,Y =K 0) 0.20

iv) P ( Y =K 0| X=K 100 )= = =0.4
P( X=K 100) 0.50

v)

Correlation coefficient of X and Y (Corr(X,Y));

Cov ( X , Y )
Corr ( X ,Y )=
σ X . σY

Where;
Cov ( X , Y )=E ( XY )−E ( X ) . E ( Y )
Where;

E ( X ) =100 ( f x ( 100 ) ) + 250 ( f x ( 250 ) ) =100 ( 0.5 ) +250 ( 0.5 )=50+125=175

E ( Y )=0 ( f y ( 0 ) ) +100 ( f y ( 100 ) ) +200 ( f y ( 200 )) =K 0+100 ( 0.25 ) +200 ( 0.5 ) =25+100=125

E ( XY )=100 ( 0.10 ) 100+100 ( 0.15 ) 250+200 ( 0.20 ) 100+200 ( 0.30 ) 250

¿ 1,000+3,750+ 4,000+15,000=23,750
Therefore;

Cov ( X , Y )=E ( XY )−E ( X ) . E ( Y )

Cov ( X , Y )=23,750−175 ( 125 )=1,875
Also;

σ 2x =E ( X 2) −¿ and σ 2y =E ( Y 2 )−¿ where;

E ( X 2) =1002 ( f x ( 100 ) ) + 2502 ( f x ( 250 ) ) =10,000 ( 0.5 ) +62,500 ( 0.5 )=5,000+31,250=36,250

E ( Y 2 )=02 ( f y ( 0 ) ) +10 0 2 ( f y (10 0 ) ) +2002 ( f y ( 200 ) ) =0+10,000 ( 0.25 ) + 40,000 ( 0.5 )=2,500+20,000=22,500

Thus;

σ 2x =E ( X 2) −¿

σ x =√ 5,625=75

σ 2y =22,500−125 2=22,500−15,625=6,825

σ y =√ 6,825=82.92
Finally;

1,875
Corr ( X ,Y )= =0.30
75 (82.92)