In given Exercise, which company would the investor select if it were using the maximin criterion? The maximax criterion? The minimax regret criterion?
Exercise
An investor is trying to decide between two promising technology stocks to round out his portfolio. The remainder of his portfolio consists of relatively conservative companies and will not enter into his decision as to which technology company will be selected. DiskWorth is a well-established company engaged in the design and manufacture of data storage disks, while ComTranDat is a start-up firm in the midst of developing what could be a wireless communication and data transmission system superior to those currently used or under development by the leaders in its industry.
Depending on whether the technology sector weakens, remains the same, or strengthens over the next 10 years, the investor estimates that his profits with DiskWorth would be $20,000, $30,000, and $40,000, for the respective scenarios. The corresponding profits for ComTranDat are estimated to be $20,000, $10,000, and $90,000, respectively.
If the technology sector has a 20% probability of weakening over the next 10 years, a 50% probability of remaining the same, and a 30% probability of strengthening, which stock purchase should the investor make if he wishes to maximize his expected profits over the 10-year period? What is the most he should be willing to pay for a perfect forecast for the future strength of the technology sector?