Decision Theory

Debbie Gibson is considering three investment options for a small inheritance that she has Just

received stocks, bonds, and money market. The return on her investment will depend on the performance of the economy, which can be strong, average,or weak. The returns for each possible combination

are shown in the following table

Strong - Avg - Weak (percents from left to right)

Stocks: 12% 6% 10%

Bonds: 7% 4% 1%

Market: 4% 3% 2%

Assume that Debbie will choose only one of the investment options.

(a) Which investment should Debbie choose if she uses the maximax criterion?

(b) Which investment should Debbie choose if she uses the maximin criterion? .

(c) Which investment should Debbie choose if she uses the equally likely criterion?

(d) Which investment should Debbie choose if she uses the criterion of realism with OL = 0.5?

(e) Which investment should Debbie choose if she uses the minimax regret criterion?

Gibson has assigned the probability that the economy will be strong, average, and weak

at 0.2, 0.35, and 0.45, respectively.

(a) Using EMVs, what option should Debbie choose? What is the maximum EMV? _

(b) Using EOL, what option should Debbie choose? What is the minimum EOL?

(c) Compute the EVPI and show that it is the same as the minimum EOL