MCIS6123 Decision Science (Prof.

Maull) / Spring 2023 /

HW1
Points Possible Due Date Time Commitment (estimated)
40 Sunday, April 16 @ Midnight up to 12 hours

• GRADING: Grading will be aligned with the completeness of the objectives.

• INDEPENDENT WORK: Copying, cheating, plagiarism and academic dishonesty are not tolerated by University or
course policy. Please see the syllabus for the full departmental and University statement on the academic code of honor.

OBJECTIVES
• Build payoff and regret tables; build decision trees from payoff tables; compute decisions under ignorance and risk.
• Apply Laplace’s Criterion, Hurwicz Criterion and Expected Value.
• Read the paper on Bayesian decision theory by Economou, et al and answer the questions about it

WHAT TO TURN IN
You are being encouraged to turn the assignment in a PDF, but you may also use MSWord or Markdown (text).
Please submit your file directly in Blackboard in one of three formats: PDF, Word (docx) or .md (markdown text file).

ASSIGNMENT TASKS
(35%) Build payoff and regret tables; build decision trees from payoff tables; compute decisions under ignorance and
risk.
In lecture, we talked and read about payoff tables, decision making under ignorance, risk and decision trees. In this part, we
will build both payoff an regret tables and apply our knowledge to developing a decision tree for these.
Brockhouse Partners is a investment firm trying to understand how to rebalance the portfolio for several of their clients. The
rebalancing requires them to take into account the various economic conditions forthcoming. At the moment, there are no
hunches about what is going to happen (e.g. there is no idea what the probability of the economic state will be), but there are
only four possible economic states to be considered:
• recession
• severe recession
• no growth
• low growth
Since Brockhouse must work through their decision under ignorance, and will therefore have to determine what to do based on
the risk preference of each client.
There are three funds they must immediately decide on F1, F2 and F3. They think that the payoffs for F1, F2 and F3, will be:
• 0, -5, -10, respectively, in a recession,
• -5, 0, -10 in a severe recession scenario,
• 20, 10, 10 in a no growth scenario, and
• 40, 20, 55 in a low growth scenario.
§ Task: Use the data above to build the payoff and regret tables. Recall, the regret is computed by taking the maximum payoff
for any given state of nature and subtracting the actual payoff for that state of nature and action. You may put the actions along
the columns.

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§ Task: Brockhouse calls their top client, Shafra Unroch, who tells them that they are looking to take more conservative approach
this coming year. Which preference strategy are they going to be using and what will the optimal conservative decision under
ignorance be?
§ Task: There is a nice and free online tool for building decision trees called SilverDecisions. Please visit the website SilverDe-
cisions.pl and build the decision tree from the payoff table. You may benefit from reading the short tutorial on how to use the
tool here since we did not spend much time in class talking about building trees (so in a sense reading the tutorial is part of the
homework).
Turn in the exported image (or screen shot) of your decision tree and make sure it is inserted into your document that you turn
in and clearly marked.

(25%) Apply Laplace’s Criterion, Hurwicz Criterion and Expected Value.

In class we talked about decision making under ignorance and the problem of not having probabilities to the states of nature.
There are, in fact, ways to assign probabilities in decision making under ignorance. One is called the principle of indifference,
principle of insufficient reason or also called Laplace’s Criterion. This technique acts as a bridge toward probabilistic reasoning in
ignorance contexts, since it suggests that in order to attack uncertainty rationally, that probability must be used.
Another method is called the Hurwicz Criterion. Instead of assigning equiprobable values to the states of nature, a coefficient of
optimism, 𝛼, is introduced. This coefficient assigns to 𝛼 a probability of optimism to the states of nature, where 𝛼 = 0 indicates
extreme pessimism about the states of nature, and 𝛼 = 1 indicates extreme optimism. Thus, the coefficient of optimism is 1 − 𝛼.
Anything between 0 and 1 indicates a corresponding range of optimism (closer to 𝛼 = 1) and pessimism (closer to 𝛼 = 0) and
indifference (𝛼 = 0.5).

Details of the Principle of Indifference

The Laplace Criterion assumes that if there is no information on the probablities of the states of nature, then the states of nature
are equiprobable. Thus, given 𝑛 outcomes, then the probability of each is 𝑛1 .
Consider a sample payoffs table, for given actions (𝑎1 , … , 𝑎𝑛 ) and states of nature (𝜃1 , … , 𝜃𝑛 ):

𝜃1 𝜃2 𝜃3
𝑎1 0 4 10
𝑎2 5 0 0
𝑎3 16 4 6

1 𝑛
The Laplace Criterion for the payoff table is 𝑛 ∑𝑗=1 (𝑎𝑖 , 𝜃𝑖 ), so that the table now looks like:

1 𝑛
𝜃1 𝜃2 𝜃3 𝑛 ∑𝑗=1 (𝑎𝑖 , 𝜃𝑖 )
1 14
𝑎1 0 4 10 3 (0 + 4 + 10) = 3
5
𝑎2 5 0 0 3
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𝑎3 16 4 6 3

So under the Laplace Criterion with the profit table above, the optimal action to choose is 𝑎3 , the action with the highest profit.
Similarly, and as we talked in class, we can compute the regret or opportunity loss of a given outcome, which for a given outcome
𝜃𝑖 and action 𝑎𝑗 , the regret is max{𝜃𝑖 } − 𝑎𝑗 . Thus, the opportunity loss table with the Laplace Criterion is :

𝜃1 𝜃2 𝜃3
𝑎1 16 − 0 = 16 4−4=0 10 − 10 = 0
10
𝑎2 16 − 5 = 11 4−0=4 3
4
𝑎3 16 − 16 = 0 4−4=0 3

With the profit table, optimal decisions are made when we choose the maximum value, but with loss or regret, optimality is
accomplished when we minimize loss or regret, so we are trying to find the least value. So with the loss table above, we would
choose action 𝑎1 .

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Details of Hurwicz Criterion
As indicated before, Hurwicz Criterion assigns a mathematical value to optimism and pessimism. In the Maximin and Minimax
strategies we talked about in class, there was either an absolute optimism or absolute pessimism about the states of nature, and
while useful, does not allow for anything in between.
Again, the importance of these new methods is that under ignorance, we can move decision making a step beyond hueristic
thinking and nudge decision making into the realm of probabilistic frameworks, and toward uncertainty frameworks, rather
than complete ignorance. Indeed, these methods sit between the two, again as bridge methods, since in the real world, we may
actually at some point have enough data to assign partial or full probabilities to the states of nature.
Hurwicz Criterion moves us a bit beyond the Laplace Criterion.
The Hurwicz Criterion assumes a coefficient of optimism 𝛼 exists that allows us to assign a range of (uniform) optimism, 0 ≤
𝛼 ≤ 1 and that we are able to assign 𝛼 within that range to capture our optimism or pessimism. The Hurwicz coefficient is
thus,

𝐻 = 𝛼 max 𝑎𝑖 + (1 − 𝛼) min 𝑎𝑖

Using the same profit table above, let’s say we are fairly optimistic about the outcomes. Let’s say 𝛼 = 0.70 captures that
optimism. Thus, the table would be

max 𝑎𝑖 min 𝑎𝑖 𝐻
𝑎1 10 0 0.7 ⋅ 10 + 0.3 ⋅ 0 = 7
𝑎2 5 0 0.7 ⋅ 5 + 0.3 ⋅ 0 = 3.5
𝑎3 16 4 0.7 ⋅ 16 + 0.3 ⋅ 4 = 11.2 + 1.2 = 12.4

Expected Value Review

Recall from the lecture, expected value is the weighted probability of a given outcome. For probabilities of outcomes 𝜃, Pr(𝜃) =
𝑖
{ Pr(𝜃1 ), … , Pr(𝜃𝑛 )}, and ∑ Pr(𝜃𝑖 ) = 1. So for a given action 𝑎𝑖

𝑗
𝐸[𝑎𝑖 ] = ∑ 𝑎𝑖 Pr(𝜃𝑗 )

.
With the payoff table above, if Pr(𝜃) = {0.1, 0.4, 0.5} we would then have 𝐸[𝑎1 ] = 0 × 0.1 + 4 × .4 + 0.5 × 10 = 5.6.
Now that we have all the pieces in place, let’s take a look at the differences between each of these methods through practical
exercises continuing from our investing example above.
§ Task: Assuming the state of ignorance as usual, let’s go ahead and apply Laplace’s Criterion to understand what would the
best investment be given the payoff table from part 1 above. Please show your work.
§ Task: Now let’s assume a new client comes on board and is very optimistic. They believe that the future looks bright and only
think there is 0.15 pessimism in their decision making.
Use the Hurwicz coefficient and produce the table that is based on the payoff values. Please pick the optimum based on your
work. How does this compare with Laplace in the prior task?
§ Task: Use the Hurwicz coefficient to develop the table based on the regret table. Remember you will be minimizing regret.
Use the same pessimism as before (0.15). Discuss how your answer varies from the payoff table in the prior task.
§ Task: Now, we will apply expected value to another top client Munemori, has a few ideas about what the economy is going to
look like and suggests to Brockhouse that they feel the economy has a
• 0.30 chance of recession,
• 0.35 chance of severe recession,
• 0.20 chance of no growth, and
• 0.15 chance of low growth.

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This now provides Brockhouse a chance to develop a different strategy based on risk and the probabilities given to them by the
client.
What should the best fund be to put Mochizuki into using the expected value? Please show your work, and you may do the
calculations by hand or if you’d like you may use the decision tree as a solution by applying the appropriate data.

(20%) Read the paper on Bayesian decision theory by Economou, et al and answer the questions about it
In class we had a basic introduction to Bayesian decision models with simple, contrived examples. The reality is that these tools
are indeed used in the real world for significant problems.
Weather is an area that has been significantly impacted by a variety of modeling techniques and theories, but the corresponding
natural hazards that are the result of inclement weather is a clear example of decision making under uncertainty.
Bayesian frameworks perform well with uncertainty while at the same time, providing an interesting opportunity to commu-
nicate gradients of hazards with less heuristic information that often just confuse end stakeholders anyway.
Read the following paper:
• T. Economou, D. B. Stephenson, J. C. Rougier, R. A. Neal, and K. R. Mylne, “On the use of Bayesian decision theory for is-
suing natural hazard warnings,” Proc. R. Soc. A., vol. 472, no. 2194, p. 20160295, Oct. 2016, doi: 10.1098/rspa.2016.0295.
[Online]. Available: https://royalsocietypublishing.org/doi/10.1098/rspa.2016.0295.
in which you will read about some of the issues in communicating hazards as well as how decision theoretic models such as
Bayesian might find value.
§ Task: PLEASE ANSWER THE FOLLOWING QUESTIONS AFTER READING THE PAPER:
Each question is worth two points (of the 15 total for this part), except where specified.
1. (3 points) In your own words, summarize this paper in one paragraph. You answer needs to be at least 4 sentences and
no more than 350 words.

2. Early in the paper why do the authors suggest hueristic-based hazard warnings are problematic?
3. Why do the authors believe their approach is novel?
4. For the data model labeling, how many categories were used to describe precipitation impact?
5. Why was it chosen to provide the end user with higher warning levels than the forecaster?
6. Which model incurred the lowest (least) losses (CLIM, CAL, ENS, PERF)?.
7. In the discussion, what do the authors is the downside of using more complex models for their work?