Assignment:
Decision Alternatives
Apply various methods to determine the best investment given three possibilities and three future economy scenarios.
Investment Details:
Milton Moneyman, a very wealthy investor, built his fortune through his legendary investing knowledge.
At present, he has been offered three investments from which to choose.
1. A conservative investment that would perform quite well in an expanding economy and suffer only a small loss in a worsening economy.
2. A speculative investment that would perform extremely well in an expanding economy, but do quite poorly in a worsening economy.
3. A countercyclical investment that would suffer some loss in an expanding economy, but perform well in a worsening economy.
Moneyman believes that there are three possible economic scenarios during the lives of these investments:
• An Expanding Economy
• A Stable Economy
• A Worsening Economy
He is somewhat pessimistic about where the economy is headed and has assigned probabilities of 0.1, 0.5, and 0.4 respectively to these three economic scenarios. He also estimates his profits under these respective scenarios as shown in the following payoff table.
|
Investment
|
Expanding Economy
|
Stable Economy
|
Worsening Economy
|
|
Conservative Investment
|
$30 Million
|
$5 Million
|
-$10 Million
|
|
Speculative Investment
|
$40 Million
|
$10 Million
|
-$30 Million
|
|
Countercyclical Investment
|
-$10 Million
|
$0
|
$15 Million
|
|
Probability
|
0.1
|
0.5
|
D.4
|
Instructions:
1. Considering this data, explain which investment he should make based on an Expected Monetary Value (EMV) criterion.
2. Upon reflection, Daddy Warbucks does not have a great deal of confidence in the accuracy of his probability estimates. Explain which investment he should make under each of the following criteria.
a) Maximax
b) Maximin
c) Realism Criterion with indices of 0.25, 0.65, and 0.85
d) Equally Likely States of Nature
e) Minimax Regret
3. Briefly describe how Warbucks might leverage Bayes' Theorem (Bayes' Decision Rule) to improve his confidence about his probability estimates if he believes that the 10% estimate for an expanding economy is accurate, but is unsure about the odds of the other two scenarios.