Class 2

1
Class 2

• Group assignments
• Questions from last week
• Data Envelopment Analysis (Sec. 4.8)
• Kuwait stock market case
• Introduction to Decision Analysis

2
Data Envelopment Analysis

• Applications
• assessing performance of operating units
• Concept of efficiency
• Comparing operating units
• Using Solver to find efficient and inefficient
  operating units

3
Kuwait Case

• Overview
• ABCs of optimization
• Calculating financial strategies

4
Decision Analysis

• A logical framework for making decisions when
  decisions have uncertain outcomes.
• (A way to organize and analyze information to
  serve the decision maker.)

5
Decision Analysis Topics

• Payoff tables
• Optimality criteria
• Applications
• Sensitivity analysis
• DataTables in Excel

6
An Investment Example
7
Maximax Criterion
Choose the decision whose largest payoff is as
large as possible

• Bonds 120
• Stocks 150
• CDs 65
• (Cost environment Minimize the smallest cost)

Optimal
8
Maximin Criterion
Choose the decision whose smallest payoff is as
large as possible.

• Bonds 30
• Stocks -20
• CDs 65
• (Cost environment Minimize the largest cost)

Optimal
9
Hurwicz Criterion (a0.4)
Use a weighted average of the best and worst
outcomes (a is the optimism index).

• Bonds .4(120).6(30) 66
• Stocks .4(150).6(-20) 48
• CDs .4(65).6(65) 65

Optimal
10
Table of Regrets (Op. Losses)
11
Minimax Regret
Choose the decision whose largest regret is as
small as possible.

• Bonds 35
• Stocks 85
• CDs 85

Optimal
12
An Investment Example
13
Expected Monetary Value
Choose the decision whose EMV is as large as
possible.

• Bonds .5(120).3(60).2(30) 84
• Stocks .5(150).3(30).2(-20) 80
• CDs .5(65).3(65).2(65) 65
• (Cost environment minimize EMV of costs)

Optimal
14
EMV is Risk-neutral

• Game 1
• Heads Win 2
• Tails Lose 0
• EMV .5(2).5(0) 1
• Game 2
• Heads Win 1,000,004
• Tails Lose 1,000,000
• EMV .5(1000004).5(-1000000) 2

15
Applications

• Energy
• hauling coal
• transmission lines
• nuclear safeguards
• plant siting
• oil well drilling
• Medical
• treat or wait?

• Manufacturing
• product redesign
• reliability
• adding capacity
• Strategy
• settle out of court?
• launch new product
• petroleum reserve