Documente Academic
Documente Profesional
Documente Cultură
David Ramsey
Room: B2-026
e-mail: david.ramsey@ul.ie
website: www.ul.ie/ramsey
1 / 68
Recommended Text
2 / 68
Outline of Course
3 / 68
5 / 68
6 / 68
Utility
7 / 68
8 / 68
9 / 68
10 / 68
11 / 68
12 / 68
13 / 68
If a person has a utility function such that u !! (x) = 0 for all x (i.e.
u(x) is linear), then that individual is said to be risk neutral.
When presented with the choice between a fixed sum of money k
and lottery in which the expected prize is k, such an individual is
indifferent between these choices (he/she has the same expected
utility).
14 / 68
15 / 68
Example 1.1
Consider the following situation. A contestant in a game show
must choose between
a) A guaranteed reward of 125 000 Euros
b) Taking one of two bags. One of the bags is empty,
the other contains 250 000 Euro.
It can be seen that by taking option b), the expected amount of
money obtained by the player is also 125 000 Euros.
We consider 3 utility functions describing the utility of obtaining x
Euro
u1 (x) = x;
u2 (x) = x;
u3 (x) = x 2
16 / 68
Example 1.1
1
1
0 + 250000 = 125000.
2
2
17 / 68
Example 1.1
125000 353.55.
x, then by
1
1
0 + 250000 = 250.
2
2
18 / 68
Example 1.1
x1 = 250 x1 = 62500.
19 / 68
Example 1.1
1
1
0 + 2500002 = 3.125 1010 .
2
2
20 / 68
2. Decision Theory
21 / 68
Decision Theory
22 / 68
Decision Theory
In mathematical terms, suppose there are k factors.
Let wi be the weight associated with factor i and si,j the score of
option j according to factor i (i.e. how good option j is according
to factor i).
!
It is normally assumed that ki=1 wi = 1.
k
"
wi si,j
i=1
23 / 68
Decision Theory
24 / 68
Example 2.1
25 / 68
Example 2.1
The three factors I consider are price (factor 1), location (factor 2)
and time (factor 3).
I ascribe the weights w1 = 0.5, w2 = 0.3 and w3 = 0.2 to each of
these factors.
Ryanair scores s1,1 = 90 according to price, s2,1 = 40 according to
location and s3,1 = 60 according to time.
Air Lingus scores s1,2 = 70 according to price, s2,2 = 90 according
to location and s3,2 = 90 according to time.
26 / 68
Example 2.1
Hence,
u1 =0.5 90 + 0.3 40 + 0.2 60 = 69
27 / 68
Multi-player Decisions
28 / 68
Multi-player Decisions
In this case we need to define
a) Weights describing the importance of Adam and
Betty in the decision process (say p and q).
b) The weights Adam gives to the importance of
location, p1 and attractiveness, p2 and the scores he
gives to restaurant j according to these criteria r1,j
and r2,j .
c) The weights Betty gives to the importance of
location, q1 and attractiveness, q2 and the scores she
gives to restaurant j according to these criteria s1,j
and s2,j .
These scores must be made on the same scale.
29 / 68
Multi-player Decisions
Under these assumptions we can define the utility of the choice of
restaurant j to both Adam, uA,j , and Betty, uB,j .
These are simply the weighted averages of the scores each one
gives for location and attractiveness. We have
2
"
uA,j =
pi ri,j
i=1
2
"
uB,j =
qi si,j
i=1
30 / 68
Multi-player Decisions
31 / 68
Example 2.2
For example, suppose the decision makers are of equal importance,
i.e. p = q = 0.5.
Adams weights for the importance of location and attractiveness
are 0.7 and 0.3. Bettys weights are 0.4 and 0.6, respectively.
They must choose between 2 restaurants. Adam assigns a score of
70 (out of 100) for location and 50 for attractiveness to
Restaurant 1 and a score of 40 for location and 90 for
attractiveness to Restaurant 2.
The analogous scores given by Betty are 50 and 60 (to Restaurant
1) and 30 and 80 (to Restaurant 2).
32 / 68
Example 2.2
33 / 68
Example 2.2
34 / 68
35 / 68
Example 2.3
36 / 68
Example 2.3
37 / 68
Example 2.3
It should be noted that if the odds are valid only before the ground
conditions are known, we are only really interested whether these
horses win or lose and not in whether the ground is good or not.
Hence, to simplify the decision tree, we calculate the probability
that a horse wins. Let A be the event that the first horse wins and
let B be the event that the second horse wins.
Let G be the event that the ground is good or firmer (G c is the
complement of event G , i.e. not G ).
38 / 68
Example 2.3
39 / 68
Example 2.3
The simplified decision tree for this problem is given by
Choice
!#
!
#
I!
# II
!
#
!
#
!
"
#
$
%'
%'
% '
% '
' loses
wins %
wins %
' loses
'
%
'
%
'
%
'
%
'(
%&
'(
%&
10
-10
20
-10
In the case where risk exists, there are various criteria for choosing
the optimal action.
The first criterion we consider is the criterion of maximising the
expected amount of the good to be obtained.
This criterion is valid for individuals who are indifferent to risk (i.e.
have a linear utility function).
Here we should maximise the expected winnings.
41 / 68
42 / 68
43 / 68
Suppose now the signal was observed before the bet was made. In
this case we may base our bet on the signal, using the posterior
probabilities of each horse winning.
These are the conditional probabilities of the horses winning given
the state of the ground.
Hence, we should define the decision to be made when the
conditions are good or firmer DG and the decision to be made
when the conditions are different DNG .
44 / 68
45 / 68
46 / 68
47 / 68
48 / 68
49 / 68
50 / 68
51 / 68
52 / 68
53 / 68
54 / 68
55 / 68
56 / 68
sj
57 / 68
sj
58 / 68
Example 2.4
Suppose a farmer can plant corn (a1 ), wheat (a2 ), soybeans (a3 ) or
use the land for grazing (a4 ).
The possible states of nature are: heavy rainfall (s1 ), moderate
rainfall (s2 ), light rainfall (s3 ) or drought (s4 ).
59 / 68
Example 2.4
a1
a2
a3
a4
s1
-20
40
-50
12
s2
60
50
100
15
s3
30
35
45
15
s4
-5
0
-10
10
Using the four criteria given above, determine the action that the
farmer should take.
60 / 68
Example 2.4
Using Laplaces criterion, we assume each of the states is equally
likely and we calculate the expected reward obtained for each
action E (W ; ai ).
We have
20 + 60 + 30 5
= 16.25
4
40 + 50 + 35 + 0
E (W ; a2 )=
= 31.25
4
50 + 100 + 45 10
E (W ; a3 )=
= 21.25
4
12 + 15 + 15 + 10
E (W ; a4 )=
= 13
4
E (W ; a1 )=
Example 2.4
Under the minimax criterion, we maximise the minimum possible
reward. For a given action, the minimum possible reward is the
minimum value in the corresponding row.
Let Wmin (ai ) be the minimum possible reward given that action ai
is taken
Wmin (a1 ) = 20;
Wmin (a2 ) = 0;
Wmin (a4 ) = 10.
Under this criterion, the farmer should take action a4 (use for
grazing).
62 / 68
Example 2.4
63 / 68
Example 2.4
a1
a2
a3
a4
s1
60
0
90
28
s2
40
50
0
85
s3
15
10
0
30
s4
15
10
20
0
64 / 68
Example 2.4
In order to choose the appropriate action, we apply the minimax
criterion to the regret matrix.
Since regret is a cost (loss), we minimise the maximum regret.
Let Rmax (ai ) be the maximum regret possible given that action ai
is taken. We have
Rmax (a1 ) = 60;
Rmax (a4 ) = 85
65 / 68
Example 2.4
sj
66 / 68
Example 2.4
Similarly,
0 + 50
= 25
2
50 + 100
= 25
H(a3 )=
2
10 + 15
H(a4 )=
= 12.5.
2
H(a2 )=
67 / 68
Example 2.4
68 / 68