Decision & Game Theory

Chapter 3: Decision Under Risk

Sonia REBAI
Tunis Business School
University of Tunis
In many decision-making situations, we can obtain probability assessments
for the states of nature. When such probabilities are available, to identify
the best decision alternative, four possible criteria can be used

• Maximum Likelihood Criterion

• Expected Monetary Value (EMV)

• Expected Opportunity Loss

• Expected-Variance Criterion
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Maximum Likelihood Criterion

The DM Identifies the most likely event, ignores others, and picks act with
the best payoff.

(0.2) (0.4) (0.1)S (0.3)

S1 S2 3 S4
a1 250 350 350 400 350 Max

a2 225 300 380 420 300

a3 200 200 400 500 200

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Expected Monetary Value (EMV)

The DM calculates for each alternative the weighted average payoff,
then he selects the act providing the best expected value.

(0.2) (0.4) (0.1) (0.3)

EMV
S1 S2 S3 S4

a1 250 350 350 400 345 Max

a2 225 300 380 420 329

a3 200 200 400 500 310

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Expected Opportunity Loss (EOL)

The DM computes the weighted average of the opportunity losses for
each alternative.

(0.2)S (0.4) (0.1) (0.3) EOL

1 S2 S3 S4
a1 0 0 50 100 35 Min
a2 25 50 20 80 51
a3 50 150 0 0 70

Note that EMV and EOL yield the same optimal decision. 5
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Expected Value-Variance Criterion

• The DM optimizes both the EV and the variance.
• In the case of a maximization problem, the DM Maximizes (E(Z)-ks(Z)),
where Z is a random variable representing payoff and k is a predefined
constant reflecting the decision-maker's risk aversion factor. It is used as
a weight indicating the degree of importance of the variance of Z in
relation to its expected value. For example, a decision maker who is
particularly sensitive to results far below EV will choose a value for k
greater than 1.
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Let’s suppose that k=1.

(0.2) (0.4) (0.1) (0.3)

E(Z) E(Z²) Var = E(Z²)-E(Z)² E(Z)-s(Z)
S1 S2 S3 S4
a1 250 350 350 400 345 121750 2725 292.798 Max

a2 225 300 380 420 329 113485 5244 256.585

a3 200 200 400 500 310 115000 18900 172.523