Exhibit 14.5
The following questions are based on the information below.
An investor is considering 4 investments, A, B, C, D. The payoff from each investment is a function of the economic climate over the next 2 years. The economy can expand or decline. The following decision tree has been developed for the problem. The investor has estimated the probability of a declining economy at 40% and an expanding economy at 60%.
-The decision rule which selects the alternative associated with the smallest maximum opportunity loss is the
A) maximax decision rule.
B) maximin decision rule.
C) minimax regret decision rule.
D) minimin decision rule.

Question

Exhibit 14.5
The following questions are based on the information below.
An investor is considering 4 investments, A, B, C, D. The payoff from each investment is a function of the economic climate over the next 2 years. The economy can expand or decline. The following decision tree has been developed for the problem. The investor has estimated the probability of a declining economy at 40% and an expanding economy at 60%. 
-The decision rule which selects the alternative associated with the smallest maximum opportunity loss is the
A) maximax decision rule. 
B) maximin decision rule. 
C) minimax regret decision rule. 
D) minimin decision rule.

Quizplus · Accepted Answer

The minimax regret decision rule selects the alternative that minimizes the maximum regret. In this case, we can calculate the regret for each alternative by subtracting the payoffs for each economic state from the maximum payoff for that state. Then, we can select the alternative with the smallest maximum regret. Using this rule, the best choice is alternative B, which has a maximum regret of only 1 compared to alternatives A, C, and D which all have maximum regrets of 2 or 3. Therefore, the investor should choose alternative B.

Exhibit 14.5 The Following Questions Are Based on the Information Below