Tuesday, July 25th, 2023.

Final Applied Project 2023A

Professor: Nicholas Sabin

Subject: Decision Making
Integrants: Alvaro Cortés / 20.297.878-9
Benjamín Pino / 21.022.776-8
Valentina Zepeda / 20.036.190-3
Words: 3000
We are the financial consultancy for stocks "VAALBE." Our financial consultants aim
to provide suggestions and interventions with the best applicable strategies to
improve your finances, which can include investments and meet all the needs,
objectives, and goals of your organization. With over 10 years of experience in the
stock market, we understand its fluctuations and risks. On July 15, 2023, the
company "LoL" approached us for help with a significant stock investment. They had
three company options to invest in: firstly, Cortés S.A., a technology company
specialized in cellphone production with 30 years in the market and supported by
the Korean government; secondly, Anderson S.A.; and lastly, Quinsacara S.A.
Therefore, we will conduct a decision-making diagnosis.
Our motivation for selecting this topic is to help professionals in the finance and
economics field, such as those pursuing a Commercial Engineering career, generate
a decision model for investments. This model can enhance their ability to make solid
and effective financial decisions. Furthermore, such a model can assist commercial
engineers in managing risks and identifying promising investment opportunities.
Making investment decisions is complex due to the multitude of variables to consider.
To make sound decisions, a decision model is essential to evaluate available options
and select the best one, taking into account factors such as risk, profitability, and
investment horizon. This approach can lead to informed decisions and ultimately
better financial results. Working with a well-structured model, commercial engineers
can improve their evaluation and analysis skills over time, which is crucial for their
professional development.
The decision-making process, as explained by Hastie & Dawes in their book
"Rational Choice in an Uncertain World: The Psychology of Judgment and Decision
Making," consists of three parts:
• Option: There is more than one possibility.
• Goal: The possible outcomes can be evaluated in terms of goals or values.
• Expectations: The decision-maker may have expectations about the result in terms
of beliefs or probabilities.
In this case:
Goal: The company "LoL" aims to maximize its profits by investing USD 50,000 in
one of these three companies: "Cortes SA," "Anderson SA," and "Quinsacara SA."
Option 1: The first option to consider is to invest in "Cortés S.A." This is a technology
company specialized in cellphone production with 30 years in the market and is
supported by the Korean government.
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Option 2: The second option to consider is to invest in "Anderson S.A.," which is a

cosmetics manufacturing company. Currently, they are innovating in new testing
technologies and new formulas for their products.
Option 3: The third option to consider is to invest in "Quinsacara S.A.," a company
dedicated to cryptocurrency trading. In the past, this market experienced exponential
growth, but since 2021 and the decline in cryptocurrency prices, the future of this
market is uncertain.
Expectation: The return expectations for each option are based on proportional
probabilities. Below, I present the expectations for each company: An investor might
base their decision on information that is easily remembered or available now, rather
than an objective evaluation of all investment options. For example, if the investor
recently heard from a friend who succeeded in investing in cryptocurrencies, they
might choose the "Quinsacara S.A." option without further in-depth research.
If the investor is influenced by emotions, they may make impulsive and irrational
decisions based on momentary feelings rather than an objective evaluation of each
option. For example, if the investor is drawn to the idea of investing in a technology
company, they might choose the "Cortés S.A." option without considering their own
investment needs and objectives. The investor may be reluctant to change their
current investment behavior and opt for what is familiar instead of exploring new
possibilities. For example, if the investor has always invested in cosmetic-related
products, they might choose "Anderson S.A." without considering other options.
However, it is important to consider that each investor may have cognitive biases
depending on their level of risk aversion personally. Thus, each investor's decision
could significantly vary, favoring an option that is logically correct but aligns more
with their level of accepted risk and comfort, regardless of the potential return it may
yield.
To address this decision-making topic, it will be necessary to create a rational model
with the following characteristics: full time, information, and cognitive capacity. To
develop the decision, we will rely on Kahneman's book "Thinking, Fast and Slow,"
where he mentions various ways to maximize expected utility, which are as follows:
Firstly, using "System 2," as the decision-maker has time, information, and cognitive
capacity, enabling them to make a more analytical choice and reflective. Another
way would be to identify and evaluate all available options, avoiding focusing on only
one option or having a predisposition. And finally, applying the "Expected Utility
Theory," which will require three aspects: the possible choices, which in this case
would be "Cortés S.A," "Anderson S.A," and "Quinsacara S.A," the probabilities, and
the value of each choice, to develop the "Expected Utility Equation" and determine
the best option through the summation of each choice.
For the company "Cortes SA," due to its historical growth and support from the
Korean government, it is assumed to have an 80% probability of obtaining a return
of USD 150,000 and a 20% probability of obtaining a return of USD 30,000.For the
company "Anderson SA," as the acceptance of the new products by customers is
uncertain, it is assumed to have a 60% probability of obtaining a return of USD
190,000 and a 40% probability of obtaining a return of USD 40,000.
For the company "Quinsacara SA," due to the uncertainty of this market, it is
assumed to have a 30% probability of obtaining a return of USD 300,000 and a 70%
probability of obtaining a return of USD 10,000.
To develop this, we will use the decision tree since it is a graphical and structured
representation of the set of decisions. Additionally, it provides the possibility to
visually discern the best alternative.
For the creation of our rational decision model through a tree model, we have
mapped the different decision options, which are shown by 3 investment options
along with their expected returns and their risk probabilities, so our model is specially
based on the probability, uncertainty and risk associated with each option. A multi-
attribute model has been constructed that considers both the expected return and
the uncertainty or risk associated with each option. According to Hastie & Dawes
(2010) Rational Choice in an Uncertain World, Chapter 2, the construction of multi-
attribute models may be appropriate if more complete and detailed information on
the attributes is available, as is the case here. In which a decision tree model has
been generated, where investment options, their expected returns, and their risk
probabilities are mapped into a hierarchical decision tree. The possible outcomes of
each option are probabilistically evaluated and the option with the highest expected
rate of return or the highest ratio of expected rate to risk assumed is chosen,
depending on the investor's objectives and risk appetite. Ultimately, the decision will
depend on the framework of individual preferences and the investor's assessment
of the possible outcomes and their consequences.
After this we can talk about the concept of Rationality, due to the characteristics of
the case (full time and information, capacitive cognitive) at the time of its
development the concept of rationality will be used, which Simon defined in his book
"A Behavioral Model of Rational Choice" as the ability to make decisions in an
informed and coherent manner, using the best available information and pursuing
objectives consistent with the preferences of the individual. And 4 criteria of
rationality are found.
1) Stable preferences: The decision-maker knows what his preferences are, so his
decisions must be adjusted to them. In the present case, this is reflected in the fact
that the company "LOL" has stable preferences in maximizing its profits.
2) Relevant information: the decision maker must have complete or significant
information, the more information the better the basis for making the decision. A has
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constant yields in the past and it is expected that in the future they will remain
constant) in addition to prospects (Anderson S.A. is not sure that its products will be
well received by customers) and market analysis (the market where Quinsacara S.A.
works is not known how it will evolve).
3) Calculative ability: the ability to evaluate the expected consequences and possible
outcomes of each option. In the present case, this is reflected in the use of the
appropriate methods (the use of Expected Utility Theory) and the appropriate
methods (the use of the decision tree).
4) Optimal choice: it is a selection that maximizes the outcome or minimizes the
insufficient outcome.in the present case, with the objective of maximizing the
benefits should choose to invest in the company Anderson S.A, since it obtains the
highest return of the three.
And in this way, we can identify the most significant biases:

1.- Loss Aversion

Loss aversion can have important implications in investment decisions. The
investing company, in our case, the "LoL" Company, may experience a strong
aversion to loss that may make conversational decisions to avoid perceived risks of
capital loss. Some of the specific implications are:
- Inaction in the face of investment opportunities: investors may avoid potentially
lucrative opportunities because they fear incurring losses. This can limit their ability
to earn higher returns.
- Holding on to losing investments: Due to loss aversion, investors may hold on to
investments that have suffered losses, rather than selling them and redeploying
funds to more promising assets.
- Bias toward less volatile assets: Loss-averse investors may prefer fewer volatile
assets, such as bonds or real estate, rather than investments that have suffered
losses.
- Bias toward less volatile assets: Loss-averse investors may prefer fewer volatile
assets, such as bonds or real estate, rather than riskier but potentially more
profitable investments, such as stocks of emerging companies.
2.-Framing bias:
Framing bias can also affect investment decisions by influencing risk perception and
return expectations. Some of the implications include:
- Biased perception of risk: Depending on how information about an investment is
presented, investors may perceive the risk associated with it differently. In this case,
the different companies where the "LoL" company wanted to invest had different risk
percentages.
- Distorted return expectations: The framework in which an investment is presented
can influence investors' return expectations. For example, a focused presentation of
Cortes S.A., Anderson S.A. and Quinsacara S.A. on earnings potential can lead to
overly optimistic expectations for the company "Lol".

3.- Anchoring Bias:

Anchoring bias can have significant implications in investment decision making as
well. Some specific implications are:
- Influence on investment strategy: the original purchase price of the stock that would
buy the "LoL" company may affect subsequent investment strategy, leading to
decisions based on the initial anchor rather than on current and relevant information.
- Behavior in volatile markets: In highly volatile markets, investors may cling to old
benchmarks, which can lead to emotional or impulsive decisions rather than
decisions based on rational analysis.
In summary, cognitive biases, such as loss aversion, framing bias, and anchoring
bias, can have a significant impact on investment decisions. Recognizing and
addressing these biases is essential to making more informed and rational
investment decisions, which can lead to stronger financial outcomes and better
portfolio management.
Kahneman, Daniel; Tversky, Amos (1984). "Choices, values, and frames.". American
Psychologist 39 (4): 341-350.
Because of this we can identify factors that exaggerate or mitigate irrational thinking,
since according to Hastie & Dawes' studies in their book "Rational Choice in an
Uncertain World", situational factors can exacerbate or mitigate irrational decision-
making behavior. For example, the context in which the decision is made can affect
the decision maker's risk perception and cognitive bias. In addition, time pressure or
stress level can lead to thoughtless decisions and lead to unintended consequences.
On the other hand, experience, prior training in decision making and appropriate
feedback can mitigate the effects of situational factors and lead to more rational
decisions. Overall, it is important to take context and situational factors into account
when making decisions and to consider how they may affect our ability to make
rational decisions.
To conclude we will apply integrative thinking and make some recommendations
regarding decision making. Considering the situation, we have outlined, we can also
make decisions from a decision-making perspective using Daniel Kahneman's
System 1 and System 2 models, in which it is important to integrate both normative
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and relevant behavioral concepts. To achieve this, the following recommendations

can be applied to make use of both systems when making the decision:

1. Evaluate investment options in terms of their returns and risks: This implies
considering both the objective data on the performance of each investment and the
emotions and biases that could influence the decision-making process. For example,
in the case in which an investor makes a first general analysis of the 3 options
presented, and depending on his cognitive biases and intuitions, deviates more for
one of the 3 companies without taking into account the logical background and only
because this one fits more to his tastes or personal experience, to then generate a
critical analysis of this option taking into account all the information and logical or
mathematical data bases, but already being within this investment alternative.
2. Balance rational and emotional analysis: In this case, the System 2 system
could help to perform a rational analysis of the data and make decisions in a more
objective way, but it is also important to consider the System 1 system to identify
symptoms of fear or overconfidence that may influence decision making. So, in this
case it is important for the investor to identify his emotions and biases present when
making an investment decision, but without letting these factors take a great weight
at that moment, but also considering the logical and objective data of his alternatives.
3. Seek expert advice and opinions: Seeking the opinion of experts in the
investment industry can be extremely valuable. Experts can provide important
information and help balance both rational and emotional analysis. By taking this
situation from an outsider's perspective, your investment advisors will give you a
logical answer based on a technical analysis of the investments, so the investor can
take this objective analysis into account and based on his needs, evaluate whether
these options fit what he wants or not.
4. Take a balanced approach to risk: Evaluate investment options in terms of risk
and return. A balanced investment approach should seek to diversify investments,
which can reduce overall portfolio risk.
It is important to remember that investment decisions should be tailored to each
investor's needs as well as their risk threshold. Integrating relevant normative and
behavioral concepts through these tips can help make realistic and useful decisions
in the context of investment decision making.

Some of the practical steps that could facilitate the decision maker, is to stick to the
steps of cognitive load reduction, in this case to the advisors "VAALBE" and the
manager of "LoL" to clear their mind and stay focused only on the options of the
stock investment companies: "Cortes S.A", "Anderson S.A" and "Quinsacara S.A".
The theory of cognitive load reduction was proposed by John Sweller, an Australian
cognitive psychologist. In the 1980s, Sweller developed the concept of cognitive load
as part of his research on how the human mind processes and assimilates
information during learning. Reducing cognitive load is essential to making more
effective decisions and improving the quality of the choices we make in various
contexts, in this case stock investment decision making. Here are some specific
strategies I can share to achieve this goal:
1.- Simplify information: present data and information in a clear and concise manner.
Avoid using unnecessary technical language and provide clear and direct
explanations. That the companies where we are thinking of making our investment;
Cortés S.A, Anderson S.A, Quinsacara S.A, provide us with precise and clear
information about the return that they could offer us.
Use visual aids: Incorporate graphs, diagrams, and tables to represent complex
information. Visual aids can facilitate understanding and reduce the cognitive load
by processing information in a more intuitive way, in this case the decision tree with
the probabilities of the results of each possible investment.
4.- Prioritize the important aspects: Highlight the key elements or critical points in the
decision-making process. This helps to focus attention on what is most relevant and
reduces the distraction of irrelevant information. In this case, be clear about the %
risk of each investment.
Avoid information overload: Limit the amount of information presented at a time to
avoid cognitive overload. Providing information gradually and sequentially can
improve data assimilation and retention.
Additionally, as mentioned above, when deciding, individuals can make use of both
"system 1" and "system 2", but to make a more realistic decision in the present case,
the financial situation of the companies, their business objectives and market
conditions must be considered. It should not only consider the possible returns, but
also the probability of success of each investment. At the same time, the VAALBE
team must recognize that decision making is always subject to uncertainty and risk,
so it must seek an alternative that provides a balance between risk and return, as
this will avoid significant losses.To apply Integrative Thinking, the VAALBE team can
look for practical solutions that are coherent with the objectives of the company
"LOL" and at the same time it must take advantage of the intuition of its employees
in the market, since, in this way, the objective of making an informed and efficient
decision will be fulfilled.In this case, the decision VAALBE should take is to invest in
the company "Anderson S.A.", because it is the option that through the analysis
gives the highest profitability, in addition to having a low risk of loss. In spite of the
fact that there was a although there was a predominance at the beginning towards
"Quinsacara S.A." because the employee had experience in the market and had the
intuition that it could be the best option, being a case of "Stockbrokers & Financial
Analysts", the possibility of making a rational decision taking intuition as a relevant
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factor is less relevant, since in these cases it is preferable to trust in "System 2"; in
the data and analysis that were made, so that the best option is to invest in
"Anderson S.A.".