Exhibit 14.2
The following questions are based on the information below.
An investor is considering 4 investments, A, B, C and leaving his money in the bank. 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 payoff matrix has been developed for the decision problem.
-How are states of nature assigned probabilities?
A) Use historical data.
B) Use best judgement.
C) Use interview results.
D) All of these.

Question

Exhibit 14.2
The following questions are based on the information below.
An investor is considering 4 investments, A, B, C and leaving his money in the bank. 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 payoff matrix has been developed for the decision problem. 
-How are states of nature assigned probabilities?
A) Use historical data. 
B) Use best judgement. 
C) Use interview results. 
D) All of these.

Quizplus · Accepted Answer

Assigning probabilities to the states of nature can be done using historical data, best judgement, or interview results. Therefore, D is the correct answer. As for the best choice, it will depend on the investor's risk tolerance and preferences. One possible strategy is to calculate the expected value (EV) for each investment and choose the one with the highest EV. For example, the EV for Investment A is (0.5*1200)+(0.5*(-500)) = 350, while the EV for leaving the money in the bank is (0.5*0)+(0.5*0) = 0. Based on this calculation, Investment A seems to be the best choice. Another strategy is to use decision criteria such as maximin, maximax, or minimax regret to make the decision.

Exhibit 14.2 The Following Questions Are Based on the Information Below