Decision making under risk page 144

Probabilistic

• From wiki: is a way of expressing knowledge or belief that an event will occur or has occurred. More...

Stochastic

• from wiki: A stochastic process is one whose behavior is non-deterministic in that a system's subsequent state is determined both by the process's predictable actions and by a random element. More...

Decision maker must consider several possible outcomes for each alternative, each with a given probability of occurance.

Modeling with decision trees

A graphical representation of a decision.

• A graphical representation of relationships between variables, values and outcomes.

• Each pathway along the ‘branches’ of the tree represents a particular sequence of criteria leading to a particular outcome.

• A multiple criteria approach.

• Can model probabilistic decision-making.

• Cumbersome if there are many alternative outcomes.

Probabilistic decision-making

Making a decision under risk.

• Several outcomes could occur
• Each outcome has a probability of occurring
• Each outcome has a positive or negative value (payout) associated with it.

Risk analysis

• Calculate the value of the outcome for each alternative.
• Calculate the probability of each outcome occurring.
• Calculate the expected value of the outcome for each alternative. (= probability x value)
• Select the alternative with the best expected value.