Chapter 3 – Decision Theory S. Neuburger Decision Theory (cont.) Decision Making Under Risk – know probability of occurrence of each outcome 1. Expected Monetary Value (EMV) – sum of (payoff times probability of occurrence); choose action with largest expected value 2. Expected Value With Perfect Information (EVwPI) EVwPI = Sum of best payoff for each state times the probability of that state of nature 3. Expected Value of Perfect Information (EVPI) How much is perfect information worth? How much are we willing to pay? EVPI=(EVwPI) - (maximum EMV) 4. Expected Opportunity Loss (EOL) Create opportunity loss table Multiply opportunity loss by probability of each event and add together for each action Choose minimum EOL Note: minimum EOL and maximum EMV will result in same action and minimum EOL = EVPI. Sensitivity Analysis – how would our decision change given a change in the probabilities of the data? Decision Trees
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