||(30+5-10)/3 = 8.3
Maximin Criterion or Conservative Approach:
Don't use plagiarized sources. Get Your Custom Essay on
Warren Buffy is an enormously wealthy investor who has built his fortune through
Get an essay WRITTEN FOR YOU, Plagiarism free, and by an EXPERT!
Under this approach decision maker will evaluate the decision alternatives, in terms of the worst payoff that can occur or the alternative that provides the best of all possible minimum payoffs of each alternative selected. Thus, management should use Maximin criterion to evaluate alternatives. Under maximin principle, take the smallest payoff under each alternative and then select the largest of those minimum payoffs. This criterion is also known as pessimistic approach
Minimum payoffs of A1, A2, and A3 alternatives are -10, -30, -10 respectively.
Maximum payoff among the alternative’s minimum payoff is -10 for both alternatives A1 and A3
Thus, according to Maximin principle, Warren can select either conservative or countercyclical investment alternatives.
Maximum Likelihood criterion:
This principle is based on a simple philosophy that if there is uncertainty about various events, then treat them as equally probable to occur, that is, each state of nature or chance event is assigned an equal probability. It is also known as equal probabilities criterion. In this assumption, the expected value (EV) or average payoff for each course of action or strategy is determined and the strategy with the highest mean value is adopted.
Average payoffs of A1, A2, and A3 alternatives are 8.3, 6.7, and 1.7 respectively.
Maximum payoff among the alternative’s average payoff is 8.3 for the alternatives A1.
Thus, according to Maximum likelihood principle, Warren should select conservative investment alternative.
Bayes’ Decision rule
This rule considers the prior probabilities for the state of natures and selects the alternative with the maximum expected payoff. Expected payoff is calculated as sum of product of probabilities and payoff of each alternative.
Expected payoff of alternative A1:
EP (A1) = 0.1 x 30 + 0.5 x 5 +0.4 x (-10) = 1.5
Similarly, EP (A2) = -3 and EP (A3) = 5
Maximum Expected Value = 5
The maximum EP is $5 for the alternative of countercyclical investment, thus Warren should select countercyclical investment according Baye’s decision rule.