A further limitation of the application of preference

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Unformatted text preview: ilities used to justify a gamble. Rather, the probabilities are usually specified for a given investment, and the parameter that the decision-maker focuses on is whether the successful gain is sufficient to justify the gamble (Newendorp, 1996). A further limitation of the application of preference theory to real problems is the inability to construct corporate preference curves. Hammond (1967) argues that an organisation’s propensity for risk is higher than that of an individual, and that therefore companies’ preference curves are usually more risk seeking than those of individuals’. However, Hammond believes, that the individual manager could unwittingly apply his own much more conservative preference curve when making decisions on behalf of the company. Therefore, Hammond (1967) concludes that organisations should have a corporate preference curve for individual mangers to use when making company decisions. However, whilst research into constructing corporate preference curves has been attempted, its theoretical results have, to date, been too complex for practical application (Hammond, 1967). Recently, though one company based in Aberdeen, Det Norske Veritas (DNV), has started offering preference theory-based analysis to upstream companies. Despite these limitations, proponents of preference theory claim that it provides the decision-maker with the most representative decision parameter ever developed. They argue that its use will produce a more consistent decision policy than that which results from using EMV and that preference theory also accounts for the non-arbitrary factors in an arbitrary way (Swalm, 1966). Others are more cautionary. Bailey et al. (in press) argue that proponents of preference theory should not claim that it is a descriptive tool but rather offer it as a prescriptive technique that can be used to help individuals or companies take decisions. They write: 96 “…preference theory does have a more limited but still important role. It can graphically demonstrate to decision-makers what their style of decisionmaking implies. It might show a highly conservative, very risk averse decision-maker that there was room for much more flexibility without incurring enormous penalties, or it might show an intuitive decision-maker that his decision-making was altogether too risky.” However, opponents argue that it is impossible to quantify emotions regarding money, and therefore the whole idea of preference theory is an exercise in frustration (Tocher, 1977). Underpinning preference theory, the EMV concept, decision tree analysis and indeed the whole of decision analysis, as highlighted in the sections above and in Chapter 2, is the ability of the analyst to generate subjective probabilistic estimates of the variables under investigation, as a mechanism for quantifying the risk and uncertainty. Traditional probability theory relies on the relative frequency concept in which probability is perceived to be the long-run relative frequency with which a system is observed in a parti...
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This document was uploaded on 03/30/2014.

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