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Chapter 6: Further Techniques in Decisio... > 6.2 Analyzing Risk Directly

6.2 Analyzing Risk Directly

Some decision makers may not be comfortable assessing personal utility functions and making decisions based on such functions. Rather, they may want to directly analyze the risk inherent in a decision alternative. One way to do this is to use the variance as a measure of spread from the expected value. Another way is to develop risk profiles. We discuss each technique in turn.

6.2.1 Using the Variance to Measure Risk

We start with an example.

Example 6.8

Suppose Patricia is going to make the decision modeled by the decision tree in Figure 6.4. If Patricia simply maximizes expected value, it is left as an exercise to show

image

So d1 is the decision alternative that maximizes expected value. However, the expected values by themselves tell us nothing of the risk involved in the alternatives. Let’s also compute the variance of each decision alternative. If we choose alternative d1, then


  

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