MANG6134W1

SEMESTER 2 EXAMINATIONS 2017-18

RISK TAKING AND DECISION MAKING

1. A charity, FAID, which aims to alleviate poverty throughout the world, is trying to select the most appropriate strategy it should adopt in order to reduce the impact of global warming on the poorest nations.

(a)  Discuss whether objective or subjective probabilities might be the most useful in helping FAID select the most appropriate strategy.          [30 marks]

(b)  Outline the advantages to FAID of using groups, including the value of prediction markets, for making judgements

concerning the likelihood of events which might influence their decision.        [40 marks]

(c)  Outline the stages in a structured methodology, employing multiple probability assessors, that  FAID could employ to  assess the probability that global warming will lead to a reduction in the wealth of the poorest nations over the next 30 years.   [30 marks]

2. Southampton football club (S), is trying to avoid relegation, and as a result they are negotiating with Manchester City football club (M) over the price they will pay to secure M’s leading striker.

(a)  Describe the information S would need and the conditions which need to exist to enable them to model these

negotiations as a zero sum game.    [20 marks]

In an effort to improve the performance of their existing players, S are also negotiating to purchase statistical analysis of their players’ performances from Perfect Performance plc (P). S and P both believe they each have three potential strategies they can adopt in these negotiations, S1, S2, and S3 and P1, P2 and P3, respectively. They both expect that the amount (£00,000) which S will be charged for the statistical analysis will depend upon the negotiation strategies adopted by both P and S, as follows:

(b)  Identify the two potential saddle points to these

negotiations and explain how you arrived at this solution.        [20 marks]

(c)  Discuss whether either of these potential saddle points

represent a stable outcome to the negotiations.             [15 marks]

A senior member of S’s management team indicates that they agree with the estimated costs of purchasing the statistical analysis shown in the gain matrix shown above if S adopts S2 or S3. However, they believe the costs of purchasing the statistical analysis if S employed strategy S1 will be 8, 4 and 8 if P adopts strategies P1, P2 and P3, respectively. They also believe that S can also employ a new negotiating strategy S4, which results in S paying (£00,000): 1, 8 and 1 if P adopts strategies P1, P2 and P3, respectively.

(d)  If the senior member of their management team is correct, what would be P’s optimal negotiation strategy/ies and how much is S likely to pay for the statistical analysis [you can assume that there is NO saddle point solution]?               [45 marks]

3. (a)  Discuss why individuals use heuristics when making judgements.               [15 marks]

It has been found that individuals adopt the following heuristics:

(i)   They judge the probability that an event belongs to a particular ‘class’ by how ‘typical’ of that class it appears to be – irrespective of the base-rate probability of such an event belonging to that class.

(ii)  They are generally poor at adjusting probability estimates from a given starting point.

(iii)  They judge events more probable the more readily they can be pictured or recalled.

(b)  Discuss, with the aid of examples, in what way each of the findings (i-iii) can bias judgments in practice.   [65 marks]

(c)  What steps can an organisation take to reduce the chance of these biases occurring?    [20 marks]

4. The UK Government decides that, following BREXIT, it should adopt one of four possible international trade strategies (W, X,   Y and Z). The Government believes that the success of these strategies should be measured in terms of the economic growth rate in the UK over the next 5 years. They also believe that the ability of each strategy to deliver economic growth depends on the average interest rates in the US over the next 5 years (low, medium and high). Consequently, they develop the following payoff matrix:

Expected economic growth rate in the UK(%)

The UK Government are risk averse for levels of economic growth less than 2%, risk neutral for levels of economic growth between 2% and 5% and risk preferring for levels of economic growth greater than 5%.

(a)  Draw the possible shape of the UK Government’s utility

curve for levels of economic growth between 0 and 6%.      [20 marks]

(b)  Discuss to what extent the information given above is

sufficient for the UK Government to make an informed decision about which trade strategy to follow and suggest any additional information you think they need to collect.   [30 marks]

(c)  Explain how the UK Government could use the utility curve you have drawn in part (a) to determine the best trade

strategy for the UK Government to adopt [NO CALCULATION REQUIRED].    [30 marks]

Prospect Theory suggests that in the absence of an analytical approach to the problem suggested by decision analysis, the UK Government would probably assess the value of each trading strategy by combining a subjectively weighted value of the probability they attach to the likely level of US interest rates over the next 5 years (low, medium and high) with a subjectively weighted value they attach to the different levels of economic growth they expect the UK to experience.

(d)  Draw a likely shape of the Government’s probability

weighting function predicted by Prospect Theory and explain what this shape implies about the biased manner in which the Government might view the probabilities of different size.    [20 marks]

5. Describe the normative, structured approach to decision-

making suggested by decision analysis, outline its advantages and the problems of applying it in practice.    [100 marks]

6. HC Holidays, rent out holiday apartments in Croatia. The

number they rent out is highly dependent on the Summer temperatures. The managing director, Howard Crook, is considering five potential marketing strategies for the coming  year (A-E) and he  believes that the profit they will make from these rentals in the coming year will depend upon the coming Summer’s temperatures, as follows:

Profit achieved by HC Holidays

(a)  In the absence of further information, determine which strategy HC Holidays should adopt if they employed the maximax, maximin, coefficient of optimism and regret criteria.    [25 marks]

(b)  Discuss the advantages and disadvantages of each of the

decision making under uncertainty criteria employed in (a).      [25 marks]

(c)  What data would HC Holidays need in order to construct a risk/return diagram to compare strategies? Discuss the

value of HC Holidays employing a risk/return diagram when making choices between competing strategies [NO

CALCULATION REQUIRED].    [20 marks]

Howard Crook decides that the chance of low temperatures being experienced in the coming Summer is zero, that the probability of high temperatures is 0.5 and the probability of medium temperatures is 0.5.

(d)    Under which circumstances should HC holidays employ strategy A if they used the Markowitz risk adjusted statistic for making their choice of strategies?       [30 marks]