Decision Tree

Topics: Decision theory, Decision making, Risk Pages: 2 (354 words) Published: April 5, 2015
Decision Tree
A decision tree is a schematic tree shaped diagram which is used to determine a course of action or statistical probability. Each branch of the decision tree represents a possible decision or occurrence. A decision tree is important to use when planning the festival because we be able to see all of the possible outcomes for all of the options before investing and going ahead with them. From the decision tree we will be able to see how much can be made and how much can be lost when investing.

Expected value
Expected value is calculated by multiplying each of the possible outcomes by the likelihood that each outcome will occur, and summing all of those values. By calculating expected values, we can choose the scenario that is most likely to give them us our desired outcome.

Utility function
Decision Making and Utility
The expected value criterion may not be appropriate if the decision is a one-time opportunity with substantial risks.

Decision makers do not always choose decisions based on the expected value criterion. 1. A lottery ticket has a negative net expected return.
2. Insurance policies cost more than the present value of the expected loss the insurance company pays to cover insured losses. The Utility Approach
It is assumed that a decision maker can rank decisions in a coherent manner. Utility values, U(V), reflect the decision maker’s perspective and attitude toward risk. Each payoff is assigned a utility value. Higher payoffs get larger utility value. The optimal decision is the one that maximizes the expected utility.

Determining Utility Values
The technique provides an insightful look into the amount of risk the decision maker is willing to take. The concept is based on the decision maker’s preference to taking a sure payoff versus participating in a lottery.

Determining Utility Values
Indifference approach for assigning utility values
List every possible payoff in the payoff table in...
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