Statistical

Methods
IPM – Term I, September 2022

Dr. Landis Conrad Felix Michel

2.1 The Theory of Control Charts
• Control charts allow you to monitor a process and identify the presence or absence of
special causes. By doing so, control charts help prevent two types of errors.

• The first type of error involves the belief that an observed value represents special cause
variation when it is due to the common cause variation of the process. Treating common
cause variation as special cause variation often results in over-adjusting a process.

• The second type of error involves treating special cause variation as common cause
variation. This error results in not taking immediate corrective action when necessary.

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel

• To construct a control chart, you collect samples from the output of a process over time. The samples
used for constructing control charts are known as subgroups. For each subgroup, you calculate a
sample statistic. Commonly used statistics include the sample mean and range of a numerical variable.
You then plot the values over time and add control limits around the center line of the chart. The most

typical form of a control chart sets control limits that are within ± 3 standard deviations 1 of the
statistical measure of interest. Equation ( 19 .1) defines, in general, the upper and lower control limits
for control charts.

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel

 • When these control limits are set, you evaluate the control chart by trying to find whether any pattern
exists in the values over time and by determining whether any points fall outside the control limits

• Common causes of variation represent the inherent variability that exists in a process. These fluctuations
consist of the numerous small causes of variability that operate randomly or by chance.
• Special causes of variation represent large fluctuations or patterns in data that are not part of a process.
These fluctuations are often caused by unusual events and represent either problems to correct or
opportunities to exploit
IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel
• In the context of the Time Series Factor/Components, Trends, Cyclical or Seasonal Patterns
can be identified as a Special Cause Variation.

• Irregular Component can be identified as outliers/ Special Cause Variation outside the price
control limits.

• Detecting a pattern is not always so easy. The following simple rule can help you detect a
trend or a shift in the mean level of a process:

• Eight or more consecutive points that lie above the center line or eight or more consecutive
points that lie below the center line.

• Use Price Control rules to detect patterns in various series (“session9.xlsx”, worksheet
“statistical_App_Controls”).

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel
3. Decision Making
• A manager of a mutual fund in the Using Statistics scenario, you must decide whether to
purchase stock A or stock B.

• To evaluate alternative courses of action, a decision maker must list the events, or states of
the world, that can occur and consider the probability of occurrence of each event. To aid in
selecting which stock to purchase in the Using Statistics scenario, an economist for your
company has listed four possible economic conditions and the probability of occurrence of
each event in the next year. Associate a value or payoff with the result of each event.

• In business applications, this payoff is usually expressed in terms of profits or costs, although
other payoffs, such as units of satisfaction or utility, are sometimes considered.

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel

3.1 Payoff Tables and Decision Trees
• In order to evaluate the alternative courses of action for a complete set of events, one
develops a payoff table or construct a decision tree. A payoff table contains each
possible event that can occur for each alternative course of action and a value or pay off
for each combination of an event and course of action.

• Let’s consider the payoff table for 4 possible outcomes of investing 1000$ in stocks A and
B:

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel

• Decision tree for the stock selection payoff table :

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel

• For each event, one determines the opportunity loss, the amount of profit that

will be lost if the best alternative course of action is not taken:

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel

3.2 Criteria for Decision Making
• Maximax Payoff

• The maximax payoff criterion is an optimistic payoff criterion. To use this criterion, one
finds the maximum pay off for each action and then chooses the action that has the
greatest maximum payoff.

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel

• Maximin Payoff

• The maximin payoff criterion is a pessimistic payoff criterion. To use this criterion, one
finds the minimum payoff for each action and then chooses the action that has the
greatest minimum payoff.

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel

• Expected Monetary Value

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel
• Expected Opportunity Loss

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel
IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel
• Return-to-Risk Ratio
• Unfortunately, neither the expected monetary value nor the expected opportunity loss criterion
takes into account the variability of the payoffs for the alternative courses of action under
different events.

• To take into account the variability of the events (in this case, the different economic conditions),
one calculates the variance and standard deviation of each stock

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel
IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel
Coefficient of Variation :

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel
3.4 Utility Curves

• A Risk Averse Investor, will prefer the option maximizing the risk return ratio.
• A Risk Neutral Investor will choose to maximize Expected Return.
• A Risk Seeker Investor will choose to maximize Risk.

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel
References – Additional Readings
• Chapter 16, 18, 19: “Statistical Applications in Quality Management”, “Statistics for Managers,
Using Microsoft Excel”, 8th Edition, David M. Levine, David Stephan, Kathryn A. Szabat.

IPM – Term I, September 2022 - Dr. Landis Conrad Felix Michel