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In the book Making Hard Decisions: An Introduction to Decision Analysis, 2nd ed., Robert T. Clemen presents an example in which an investor wishes to
In the book Making Hard Decisions: An Introduction to Decision Analysis, 2nd ed., Robert T. Clemen presents an example in which an investor wishes to choose between investing money in (1) a high-risk stock, (2) a low-risk stock, or (3) a savings account. The payoffs received from the two stocks will depend on the behavior of the stock marketthat is, whether the market goes up, stays the same, or goes down over the investment period. In addition, in order to obtain more information about the market behavior that might be anticipated during the investment period, the investor can hire an economist as a consultant who will predict the future market behavior. The results of the consultation will be one of the following three possibilities: (1) "economist says up," (2) "economist says flat" (the same), or (3) "economist says down." The conditional probabilities that express the ability of the economist to accurately forecast market behavior are given in the following table: True Market State Economist ' 5 Prediction Up Flat Down "Economist says up" 0.80 0.15 0.20 "Economist says flat" 0.10 0.70 0.20 "Economist says down" 0.10 0.15 0.60 Click here for the Excel Data File For instance, using this table we see that P("economist says up" | market up) = .80. gure 197 gives an incomplete decision tree for the investor's situation. Notice that this decision tree gives all relevant payoffs and also gives the prior probabilities of up, flat, and down, which are, respectively, .5, .3, and .2. Carry out a prior analysis of the investor's decision problem. That is, determine the investment choice that should be made and find the expected monetary value of that choice assuming that the investor does not consult the economist about future stock market behavior. (Negative answers should be indicated by a minus sign. Round your answers to 1 decimal place.) EV(HighRisk) = )(0.5) + ( )(0.3) + ( )(0.2) = EV(LowRisk) = (1000)( + (200)( ) + ( EV(SavingsAcct) = (0.5) + ( )(0.3) + ( )(0.2) = Choose ; payoff =
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