Professional Documents
Culture Documents
the values, uncertainties and other issues relevant in a given decision, itsrationality, and the resulting optimal decision. It is closely related to the field of game theory as to interactions of agents with at least partially conflicting interests whose decisions affect each other.
Contents
1 Normative and descriptive decision theory 2 What kinds of decisions need a theory?
2.1 Choice under uncertainty 2.2 Intertemporal choice 2.3 Competing decision makers 2.4 Complex decisions
3 Paradox of choice 4 Alternatives to decision theory 5 See also 6 References 7 Further reading
4.1 Probability theory 4.2 Alternatives to probability theory 4.3 General criticism
possible to relax the assumptions of perfect information, rationality and so forth in various ways, and produce a series of different prescriptions or predictions about behaviour, allowing for further tests of the kind of decision-making that occurs in practice. In recent decades, there has been increasing interest in what is sometimes called 'behavioral decision theory' and this has contributed to a re-evaluation of what rational decision-making requires (see for instance Anand, 1993).
Neumann's theory of expected utility proved that expected utility maximization followed from basic postulates about rational behavior.
Daniel Kahneman
The work of Maurice Allais and Daniel Ellsberg showed that human behavior has systematic and sometimes important departures from expected-utility maximization. The prospect theory of Daniel Kahneman and Amos Tversky renewed the empirical study ofeconomic behavior with less emphasis on rationality presuppositions. Kahneman and Tversky found three regularities in actual human decision-making, "losses loom larger than gains"; persons focus more on changes in their utilitystates than they focus on absolute utilities; and the estimation of subjective probabilities is severely biased byanchoring. Castagnoli and LiCalzi (1996),[citation needed] Bordley and LiCalzi (2000)[citation needed] recently showed that maximizing expected utility is mathematically equivalent to maximizing the probability that the uncertain consequences of a decision are preferable to an uncertain benchmark (e.g., the probability that a mutual fund strategy outperforms the S&P 500 or that a firm outperforms the uncertain future performance of a major competitor.). This reinterpretation relates to psychological work suggesting that individuals have fuzzy aspiration levels (Lopes & Oden),[citation needed] which may vary from choice context to choice context. Hence it shifts the focus from utility to the individual's uncertain reference point. Pascal's Wager is a classic example of a choice under uncertainty. It is possible that the reward for belief is infinite (i.e. if God exists and is the sort of God worshiped by evangelical Christians). However, it is also possible that the reward for non-belief is infinite (i.e. if a capricious God exists that rewards us for not believing in God). Therefore, either believing in God or not believing in God, when you include these results, lead to infinite rewards and so we have no decision-theoretic reason to prefer one to the other. (There are several criticisms of the argument.)
Intertemporal choice
This area is concerned with the kind of choice where different actions lead to outcomes that are realised at different points in time. If someone received a windfall of several thousand dollars, they could spend it on an expensive holiday, giving them immediate pleasure, or they could invest it in a pension scheme, giving them an income at some time in the future. What is the optimal thing to do? The answer depends partly on factors such as the expected rates of interest andinflation, the person's life expectancy, and their confidence in the pensions industry. However even with all those factors taken into account, human behavior again deviates greatly from the predictions of prescriptive decision theory, leading to alternative models in which, for example, objective interest rates are replaced by subjective discount rates.
Complex decisions
Other areas of decision theory are concerned with decisions that are difficult simply because of their complexity, or the complexity of the organization that has to make them. In such cases the issue is not the deviation between real and optimal behaviour, but the difficulty of determining the optimal behaviour in the first place. The Club of Rome, for example, developed a model of economic growth and resource usage that helps politicians make real-life decisions in complex situations[citation needed].
Paradox of choice
Observed in many cases is the paradox that more choices may lead to a poorer decision or a failure to make a decision at all. It is sometimes theorized to be caused by analysis paralysis, real or perceived, or perhaps from rational ignorance. A number of researchers including Sheena S. Iyengar and Mark R. Lepper have published studies on this phenomenon.[4] This analysis was popularized by Barry Schwartz in his 2004 book, The Paradox of Choice.
A highly controversial issue is whether one can replace the use of probability in decision theory by other alternatives.
Probability theory
The Advocates of probability theory point to:
the work of Richard Threlkeld Cox for justification of the probability axioms, the Dutch book paradoxes of Bruno de Finetti as illustrative of the
theoretical difficulties that can arise from departures from the probability axioms, and
the complete class theorems, which show that all admissible decision
rules are equivalent to the Bayesian decision rule for some utility function and some prior distribution (or for the limit of a sequence of prior distributions). Thus, for every decision rule, either the rule may be reformulated as a Bayesian procedure, or there is a (perhaps limiting) Bayesian rule that is sometimes better and never worse.
General criticism
Main article: Ludic fallacy A general criticism of decision theory based on a fixed universe of possibilities is that it considers the "known unknowns", not the "unknown unknowns": it focuses on expected variations, not on unforeseen events, which some argue (as in black swan theory) have outsized impact and must be considered significant events may be "outside model". This line of argument, called the ludic fallacy, is that there are inevitable imperfections in modeling the real world by particular models, and that unquestioning reliance on models blinds one to their limits. For instance, a simple model of daily stock market returns may include extreme moves such asBlack Monday (1987), but might not model the market breakdowns following the September 11 attacks.
See also
Activity-based costing Analytic Hierarchy Process
Applied Information Economics Bayesian probability Causal decision theory Choice Modelling Constraint satisfaction Decision field theory Decision making Decision making software Evidential decision theory Game theory Judge-Advisor System (JAS) Kelly criterion Morphological analysis (problem-solving) Multi-criteria decision making Neuroscience of free will Operations research Optimal decision PP (complexity) Public choice theory Rationality Rationality and power Recognition primed decision Secretary problem Stochastic dominance Two envelopes problem Two-moment decision models
References
1. Schoemaker, P. J. H. (1982). "The Expected Utility Model: Its Variants, Purposes, Evidence and Limitations". Journal of Economic Literature 20: 529563. 2. Wald, Abraham (1939). "Contributions to the Theory of Statistical Estimation and Testing Hypotheses". Annals of Mathematical Statistics 10 (4): 299326.doi:10.1214/aoms/1177732144. MR932. 3. Lehmann, E. L. (1950). "Some Principles of the Theory of Testing Hypotheses".Annals of Mathematical Statistics 21 (1): 1 26. doi:10.1214/aoms/1177729884.JSTOR 2236552.
4. Iyengar, Sheena S. and Lepper, Mark R. When Choice is Demotivating: Can One Desire Too Much of a Good Thing?. Retrieved 2009-Feb-12.
Further reading
Akerlof, George A., Yellen, Janet L. (May 1987). Rational Models of
Oxford University Press.ISBN 0198233035. (an overview of the philosophical foundations of key mathematical axioms in subjective expected utility theory mainly normative)
Arthur, W. Brian (May 1991). "Designing Economic Agents that Act like
Human Agents: A Behavioral Approach to Bounded Rationality". The American Economic Review 81 (2): 3539.
Berger, James O. (1985). Statistical decision theory and Bayesian
Decision Analysis (2nd ed.). Belmont CA: Duxbury Press. ISBN 0534260357.(covers normative decision theory)
De Groot, Morris, Optimal Statistical Decisions. Wiley Classics Library.
Management Judgment (3rd ed.). Chichester: Wiley. ISBN 0-470-86108-8. (covers both normative and descriptive theory)
Hansson, Sven Ove. "Decision Theory: A Brief Introduction" (PDF). Khemani, Karan, Ignorance is Bliss: A study on how and why humans
depend on recognition heuristics in social relationships, the equity markets and the brand market-place, thereby making successful decisions, 2005.
Miller L (1985). "Cognitive risk-taking after frontal or temporal lobectomyI.
The synthesis of fragmented visual information". Neuropsychologia 23 (3): 35969. doi:10.1016/0028-3932(85)90022-3. PMID 4022303.
Miller L, Milner B (1985). "Cognitive risk-taking after frontal or temporal
lobectomyII. The synthesis of phonemic and semantic information".Neuropsychologia 23 (3): 371 9.doi:10.1016/0028-3932(85)90023-5.PMID 4022304.
Transactions on Systems Science and Cybernetics 4 (3): 200 210.doi:10.1109/TSSC.1968.300114.Reprinted in Shafer & Pearl. (also about normative decision theory)
Peterson, Martin (2009). An Introduction to Decision Theory. Cambridge
Theory of Probability and on the Value of Science". Erkenntnis 31. (translation of 1931 article)
de Finetti, Bruno (1937). "La Prvision: ses lois logiques, ses sources
subjectives". Annales de l'Institut Henri Poincar. de Finetti, Bruno. "Foresight: its Logical Laws, Its Subjective Sources," (translation of the 1937 article in French) in H. E. Kyburg and H. E. Smokler (eds), Studies in Subjective Probability, New York: Wiley, 1964.
de Finetti, Bruno. Theory of Probability, (translation by AFM Smith of 1970
theMorgenstern-von Neumann Utility Theory". In Martin Shubik. Essays in Mathematical Economics In Honor of Oskar Morgenstern. Princeton University Press. pp. 237251.
Schotter. Selected Economic Writings of Oskar Morgenstern. New York University Press. pp. 6570.ISBN 0814777716.