68 preference theory can be extended to decisions

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Unformatted text preview: t drill Act fork Event fork Red numbers Preference from curve Best strategy Green numbers Preference for event fork Pink numbers Preference for act chosen Act not chosen Figure 5.10: Analysis using preferences 94 $130,000,0.68 Preference theory can be extended to decisions involving multiple attributes. Multiattribute preference theory (more commonly referred to as multi-attribute utility theory) shows how, provided certain conditions apply, the main decision problem can be broken into sub-problems and a single attribute preference function (or curve) can be derived for each attribute and then these can be combined to obtain a multiattribute function (Goodwin and Wright, 1991 p86). A number of methods have been proposed for performing this analysis, but the approach described by Keeney and Raiffa (1976) is the most popular. A number of researchers have questioned the application of preference theory to real problems. Most of their concerns relate to the generation of a decision-maker’s preference curve. Since, crucially, whilst von Neumannn and Morgenstern proved that a preference curve exists for each decision-maker who makes decisions consistent with the eight axioms they did not specify how to obtain this curve. Since 1944, many researchers have studied this problem, but so far, their attempts have been only marginally successful: “The unfortunate truth is that we (as a business community) do not as yet have a satisfactory way to construct an individual’s preference curve.” (Newendorp, 1996 p162) Generally researchers have attempted to describe a decision-maker’s preference curve by obtaining the decision-maker’s responses to a carefully designed set of hypothetical investment questions (Newendorp, 1996 p160; Hammond, 1967; Swalm, 1966). In these tests, the decision-maker is offered a choice between a gamble having a very desirable outcome and an undesirable outcome, and a no-risk alternative of intermediate desirability. Such tests, though, have only been marginally successful for two reasons. Firstly, the test procedures have to use hypothetical gambles and decisions rather than actual gambles. The rationale for this is that if the procedure used real decision-making situations, decision-makers generally would either accept or reject a decision without stopping to explicitly state what the probabilities would have to be for them to have been indifferent between the gamble and the no-risk alternative (Newendorp, 1996). Tocher (1977) argues that since these gambles are only imaginary, the decision-maker’s judgements about the relative attractiveness of 95 the gambles may not reflect what the decision-maker would really do. This is known as the preference reversal phenomenon and has been researched extensively (Slovic, 1995; Mowen and Gentry, 1980, Grether and Plott, 1979; Lichenstein and Slovic, 1971; Lindman, 1971) and many theories have been proposed to explain it (for example, Ordonez and Benson, 1997; Goldstein and Einhorn, 1987). Secondly, most decision-makers are not used to making decisions on the basis of a precise discernment of probab...
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