Professional Documents
Culture Documents
Insurable risks
Non-insurable risks
Investment decisions under risk:
Strategies and state of nature.
Outcome and pay-off matrix.
Risk-Return evaluation.
Risk preference.
risk seeker
risk averter
risk indifferent
Finite-horizon method
Risk discounting model.
The shackle approach.
The probability theory approach.
Sensitivity analysis.
Simulation.
Hedging.
Decision tree.
Expected Value
Combined Expected value and variance
Known Aspiration level
Most likely occurrence of a future state
Example 1
A preventive maintenance policy requires making decisions about when a
machine (or a piece of equipment) should be serviced on a regular basis in
order to minimize the cost of sudden breakdown
The decision situation is summarized as follows. A machine in a group of n
machines is serviced when it breaks down. At the end of T periods,
preventive maintenance is performed by servicing all n machines. The
decision problem is to determine the optimum T that minimizes the total
cost per period of servicing broken machines and applying preventive
maintenance
T 1
c1 Ent c2 n
EC (T ) t 1
T
T*
T
1
2
3
4
5
pt
0.05
0.07
0.10
0.13
0.18
Cumulative pt
0
0.05
0.12
0.22
0.35
EC(T)
500
375
366.7
400
450
pT
pT 2
Cum. pT2
EC(T)+varcT
0.05
0.0025 0
500
0.07
0.0049 0.05
0.0025
6312
0.10
0.0100 0.12
0.0074
6622
0.13
0.0169 0.22
0.0174
6731
0.18
0.0324 0.35
0.0343
6764
Cum. pT
Laplace Criterion
This Criterion is based on what is known as the principle of
insufficiency
ai is the selection yielding the largest expected gain
max vai , j
n j 1
ai
Example 2
A recreational facility must decide on the level of supply it must stock to meet the needs
of its customers during one of the holiday. The exact number of customers is not known,
but it is expected to be of four categories:200,250,300 or 350 customers. Four levels of
supplies are thus suggested with level i being ideal (from the view point of the costs) if the
number of customer falls in category i. Deviation from these levels results in additional
costs either because extra supplies are stocked needlessly or because demand cannot be
satisfied. The table below provides the costs in thousands of dollars
Customer Category
a1
10
18
25
a2
23
a3
21
18
12
21
a4
30
22
19
15
Max
a1
10
18
25
25
a2
23
23
a3
21
18
12
21
21
a4
30
22
19
15
30
Minimax value
maxvak , j vai , j
if v is profit
vai , j minvak , j
if v is loss
ak
ak
Max
a1
10
10
10
a2
a3
16
11
16
a4
25
15
11
25
minimax
Hurwicz Criterion
This Criterion represents a range of attitudes from the most optimistic to the most
pessimistic
The Hurwicz criterion strikes a balance between extreme pessimism and extreme
optimism by weighing the above two conditions by the respective weights and
1- , where 0<= <=1
If v(ai,j) represents profit, select the action that yields
min
max
min+(1-)max
25
15
23
15
12
21
16.5
15
30
22.5
minimum